A successful company that is making profits has a number of options. It can reinvest those profits into the company to make new products, find more customers, build new stores or factories, or make the business more efficient. It can buy back its shares so that each remaining share owns more of the company. It can also return some of that money to shareholders in the form of dividends. As part of learning what to pursue when buying shares investors need to understand how dividends work.
For investors, dividends serve as a popular source of investment income. For the issuing company, they are a way to redistribute profits to shareholders as a way to thank them for their support and to encourage additional investment. Dividends also serve as an announcement of the company’s success. Because dividends are issued from a company’s retained earnings, only companies that are substantially profitable issue dividends with consistency. Though some companies may issue dividends to create the illusion of profitability. Dividends are often paid in cash, but they can also be issued in the form of additional shares. In either case, the amount each investor receives is dependent on their current ownership stakes.
Before a dividend is distributed, the issuing company must first declare the dividend amount and the date it will be paid. It also announces the last date when shares can be purchased to receive the dividend called the called the ex-dividend date. This date is generally two business days prior to the date of record, which is the date when the company reviews its list of shareholders.
The declaration of a dividend naturally encourages investors to purchase shares. Because investors know that they will receive a dividend if they purchase the stock before the ex-dividend date, they are willing to pay a premium. This causes the price of stock to increase in the days leading up to the ex-dividend date. In general, the increase is about equal to the amount of the dividend, but the actual price change is based on market activity and not determined by any governing entity.
Investing in shares that pay dividends can be a good strategy, especially if an investor wants regular cash coming in reliably. Reliability is more important than a high payout. Dividends aren’t guaranteed. A company that paid a huge amount of money last year but may not pay it again. Investors still have to do their research and buy great companies, not just stocks that pay the highest dividends.
Even if the share price barely moves throughout the year, investors can still make money from these dividend payments. Better yet, they don’t have to sell their shares to get that money. This money gets paid to all shareholders, regardless of the number of shares they own. A retired grandmother who owns one share of the company gets her dividend the same way a wealthy hedge fund manager who has a fifty million dollar portfolio does. That’s why dividend investing is attractive: it’s reliable.
Keep in mind that a company must choose to pay a dividend. Just because it paid one last quarter doesn’t necessarily mean that it will pay one this quarter. As well, the amount paid may vary. While a reliable dividend stock regularly raises the amount of its dividend payments, not all companies do.
Companies that pay high dividends may do so because they’re good companies or because they want to attract investors to drive up the share price. It may be a sign that the share price has gone down, dramatically down, recently. You can’t know this just by looking at the share price and the high dividend amount; you have to understand the company’s business and its current financials. To start buying shares visit the ctrade website to register for free.
