The stock market generates two broad types of returns: dividends and capital gains. Capital gains occur when a stock appreciates in price and an investor sells at a higher price than he or she paid for the stock. Dividends function more like interest payments and are paid to existing shareholders directly from the revenue stream of the underlying company.
While any company can pay dividends, certain companies have historically yielded higher dividends for their shareholders than others. Dividends are a tenuous proposition for many younger, growing companies because any paid dividends subtract from a potential pool of reinvestment capital. For this reason, dividends tend to come from more established companies with solidified cash flow.
Which Sectors Pay More Dividends
Certain sectors also tend to pay more dividends than others. Historically, telecoms and utilities have capitalized on their local monopoly powers to lock in predictable revenue streams and provide excellent dividend yields. Technology stocks can sometimes pay high dividends, although with more variance than with utilities. Dividends in technology and biotech tend to be more hit or miss because of the high emphasis on growth.
Companies declare dividends to signal financial health and confidence in future prospects. However, dividend signals are strongest after a company repeatedly pays dividends over a period of time. Companies that rush to pay too many dividends too quickly may find themselves stunting growth, sabotaging cash flow or reducing their ability to handle contingencies.
(For related reading, see "Why Dividends Matter to Investors.")