Dividend

Loading the player...

What is a 'Dividend'

A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.

BREAKING DOWN 'Dividend'

The dividend rate may be quoted in terms of the dollar amount each share receives (dividends per share, or DPS), or It can also be quoted in terms of a percent of the current market price, which is referred to as the dividend yield.

A company's net profits can be allocated to shareholders via a dividend, or kept within the company as retained earnings. A company may also choose to use net profits to repurchase their own shares in the open markets in a share buyback. Dividends and share buy-backs do not change the fundamental value of a company's shares. Dividend payments must be approved by the shareholders and may be structured as a one-time special dividend, or as an ongoing cash flow to owners and investors.

Mutual fund and ETF shareholders are often entitled to receive accrued dividends as well. Mutual funds pay out interest and dividend income received from their portfolio holdings as dividends to fund shareholders. In addition, realized capital gains from the portfolio's trading activities are generally paid out (capital gains distribution) as a year-end dividend.

The dividend discount model, or Gordon growth model, relies on anticipated future dividend streams to value shares.

Companies That Issue Dividends

Start-ups and other high-growth companies such as those in the technology or biotechnology sectors rarely offer dividends because all of their profits are reinvested to help sustain higher-than-average growth and expansion. Larger, established companies tend to issue regular dividends as they seek to maximize shareholder wealth in ways aside from supernormal growth

Companies in the following sectors and industries have among the highest historical dividend yields: basic materials, oil and gas, banks and financial, healthcare and pharmaceuticals, utilities, and REITS.

Arguments for Issuing Dividends

The bird-in-hand argument for dividend policy claims that investors are less certain of receiving future growth and capital gains from the reinvested retained earnings than they are of receiving current (and therefore certain) dividend payments. The main argument is that investors place a higher value on a dollar of current dividends that they are certain to receive than on a dollar of expected capital gains, even if they are theoretically equivalent. 

In many countries, the income from dividends is treated at a more favorable tax rate than ordinary income. Investors seeking tax-advantaged cash flows may look to dividend-paying stocks in order to take advantage of potentially favorable taxation. The clientele effect suggests especially those investors and owners in high marginal tax brackets will choose dividend-paying stocks.

If a company has a long history of past dividend payments, reducing or eliminating the dividend amount may signal to investors that the company could be in trouble. An unexpected increase in the dividend rate might be a positive signal to the market.

Dividend Payout Policies

A company that issues dividends may choose the amount to pay out using a number of methods.

  • Stable dividend policy: Even if corporate earnings are in flux, stable dividend policy focuses on maintaining a steady dividend payout.
  • Target payout ratio: A stable dividend policy could target a long-run dividend-to-earnings ratio. The goal is to pay a stated percentage of earnings, but the share payout is given in a nominal dollar amount that adjusts to its target at the earnings baseline changes.
  • Constant payout ratio: A company pays out a specific percentage of its earnings each year as dividends, and the amount of those dividends therefore vary directly with earnings.
  • Residual dividend model: Dividends are based on earnings less funds the firm retains to finance the equity portion of its capital budget and any residual profits are then paid out to shareholders.

Dividend Irrelevance

Economists Merton Miller and Franco Modigliani argued that a company's dividend policy is irrelevant, and it has no effect on the price of a firm's stock or its cost of capital. Assume, for example, that you are a stockholder of a firm and you don't like its dividend policy. If the firm's cash dividend is too big, you can just take the excess cash received and use it to buy more of the firm's stock. If the cash dividend you received was too small, you can just sell a little bit of your existing stock in the firm to get the cash flow you want. In either case, the combination of the value of your investment in the firm and your cash in hand will be exactly the same. When they conclude that dividends are irrelevant, they mean that investors don't care about the firm's dividend policy since they can create their own synthetically.

It should be noted that the dividend irrelevance theory holds only in a perfect world with no taxes, no brokerage costs, and infinitely divisible shares.

RELATED TERMS
  1. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  2. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  3. Dividend Policy

    The policy a company uses to decide how much it will pay out ...
  4. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  5. Indicated Yield

    The dividend yield that a share of stock would return based on ...
  6. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
Related Articles
  1. Markets

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  2. Investing Basics

    How And Why Do Companies Pay Dividends?

    If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments ...
  3. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  4. Professionals

    Real-World Factors Affecting Dividend Payouts

    Dividend policy often comes into conflict with dividend reality.
  5. Options & Futures

    Stock-Picking Strategies: Income Investing

    Income investing, which aims to pick companies that provide a steady stream of income, is perhaps one of the most straightforward stock-picking strategies. When investors think of steady income ...
  6. Professionals

    Dividends

    We look at types of dividends, payments, policies and investor dividend preferences.
  7. Investing Basics

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  8. Investing Basics

    How And Why Do Companies Pay Dividends?

    The arguments for dividends include the idea that a dividend provides certainty about a company’s well being.
  9. Forex Education

    Payout Ratio

    Investing is a complex and often daunting experience, these equations are actually quite simple.
  10. Investing News

    Understanding How Mutual Funds Pay Dividends

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
RELATED FAQS
  1. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
  2. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  3. How do dividends affect retained earnings?

    Find out how distribution of dividends affects a company's retained earnings, including the difference between cash dividends ... Read Answer >>
  4. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  5. What is the difference between the dividend yield and the dividend payout ratio?

    Learn the differences between a stock's dividend yield and its dividend payout ratio, and learn why the latter might be a ... Read Answer >>
  6. What can cause the marginal propensity to consume to change over time?

    Learn about the dividend payout ratio and dividend yield, what the ratios measure and the difference between the dividend ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center