What are Dividends?

A dividend is a payment a company makes to its shareholders (people who own stock in the company). Dividends are usually paid to the investor as cash, in which case the investor has the option to take the money or reinvest it by buying more shares. Sometimes companies will pay dividends in the form of additional stock shares instead of paying cash.

Dividends usually represent a portion of the company's profits that it can't immediately spend on anything else. If a company is making money fairly quickly, it may not be able to use all of that money at the moment, so rather than spend it on questionable projects or purchases, it can simply give it to its shareholders.

There are two basic kinds of dividends: preferred dividends, which the company pays to holders of preferred stock at a set rate, and common dividends, which go to holders of common stock and vary based on the company's profits. If a company is unable to pay all of its dividends for some reason, it will pay its preferred dividends first. Most US companies pay dividends on a quarterly schedule, while non-US companies often pay dividends on a semi-annual or even annual schedule.

As a rule of thumb, companies that pay regular dividends are a safer investment than companies that don't. A regular dividend is an indicator of healthy profits and a good cash flow; in other words, it's a company that is making money faster than it can spend it, which is certainly a good sign! Investors are also more likely to hold onto stocks that pay dividends, so these stocks are less subject to large buying and selling cycles that cause prices to shoot up and down.

Dividends often change over time as companies issue new dividends and retire old ones. Generally speaking, a dividend goes through three important phases: announcement, ex-dividend, and payment. Announcement is the date on which the company announces the forthcoming payment of a given dividend. Ex-dividend is the last day on which someone can buy the company's shares and still be eligible for that dividend. Finally, payment is the day on which investors receive the dividend itself.

If a company chooses to pay a dividend in stock shares rather than cash, this will affect its investors' cost basis of the stock. A cost basis is how much a given stock costs an investor to buy, including commissions and other fees. It's important to track cost basis because this figure is used in investment-related tax calculations. A stock dividend will change the cost basis for that stock because the total amount an investor spent to purchase a stock is spread out over all the shares that investor owns. For example, if an investor owned 100 shares of stock at a $50 cost basis per share, and the company provides a 25-share stock dividend, the investor now owns 125 shares at a $40 cost basis. Note that this doesn't affect the actual value of the stock, just the owner's cost per share to acquire it.