The world of finance and investments is notorious for its extensive use of jargon. With a goal of enhancing financial literacy and making the world of money more transparent, we are committing to a “monthly jargon” post that focuses on debunking various financial terms that are continuously used sans explanation. This month, we are exploring a concept that has gained quite a bit of traction in the investment world throughout the past few years: dividends. When we hear the word “dividend,” we may have flashbacks to a sixth-grade math class and think about a number being divided by another number; however, in the finance realm, the meaning is more fruitful. In financial terms, a dividend is an amount of money paid regularly by a company to its shareholders out of its profits. These distributed sums of money can be issued as cash or stock shares, with cash dividends being the most common form. Because of the appealing financial incentive, companies that regularly reward shareholders with dividends are a popular investment for many investors. A publicly-traded company that pays dividends is known as a dividend stock, and the money that drives dividends comes from a company’s net profits. Although a dividend-paying company keeps a majority of its profits internally, known as retained earnings, to fund its business, a portion of the earnings is divided among shareholders – hence “dividends” – to reward them for their investment in and support of the company. That being said, publicly-traded companies that pay dividends typically produce suitable profits.
Now, how is the amount of a dividend determined and when are dividends rewarded to investors? Given the link between dividends and a company’s profits, dividends are typically distributed to investors on a quarterly basis according to the company announcing its quarterly earnings. The board of directors of a publicly-traded company is the group that determines the issuing of dividends, and the board can decide to issue these sums at various time frames and with varying payout rates. Most dividends are paid out monthly, quarterly, or annually. Even if a dividend-paying company experiences meager profits, the company will still issue a dividend, albeit smaller than usual, to uphold its track record of doing so. If a company experiences particularly strong performance and a favorable outlook for future growth, it will even reward a one-time special dividend in addition to a scheduled dividend. A few big-name dividend payers that many of us will recognize are Apple, Intel, and Microsoft.
An important note to make is that not all high-earning companies pay dividends. Most notably, Amazon, Facebook, and Alphabet, Google’s parent company, have historically declined to issue dividends to shareholders. The companies that opt against dividend payments are typically quickly expanding and growing companies that declare it is financially wiser for them to reinvest the company profits entirely back into the organization to support their pivotal growths and expansions. These companies essentially want to invest as much as possible into future growth, and investors still favor these stocks because if the company continues to grow, shareholders’ investments will too.
All in all, investors value the companies that reward shareholders with dividends because of the innate steady-income nature of these mature companies and stocks. Dividends are one of the easiest ways for companies to reward their shareholders and deliver shareholders value beyond typical investment growth. Companies that pay dividends send a clear message of the financial stability of their entity and of the financial strength of the company moving forward.
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