The Basics of Dividends

What exactly are dividends? You've heard that you can make money by investing in companies that pay dividends, but how does that work?

By: Martin Lukac

When companies make profits, they often distribute a portion of the profits to the shareholders. The company will retain a portion of the profits for future use. Some companies hold a large portion back while others are generous in their dividend payments -- it depends on where the company is and how well it is doing financially.
Dividends are often in the form of cash, yet some companies issue stock instead. Stocks that have a good history of paying dividends are attractive to investors. These companies are solid and profitable, but often offer little growth potential in their stock. The dividend actually gives an investor a reason to purchase the stock.
The company is under no obligation to pay a dividend. There isn't a preset amount that they must pay stockholders. The company board of directors determines the dividend amount. If the company is in financial trouble or facing an overhaul, the board has every option to forego the dividend. One of the warning signs that a company is in trouble is the elimination of dividend payments.
The dividend is set at a per share basis. For example, the board may decide on a $0.30 dividend per share. If you own 1,000 shares of stock, you will get a check for $500. If you own 100 shares of stock, you can expect a check for $50.
The board sets the dividend and announces when stockholders can expect checks at the declaration date. The ex-dividend date will also be announced at this time. The list of shareholders to receive the dividend will be set on the record date. If you want to get the dividend, you must own the stock before this date.
The ex-dividend date falls a couple of days before the record date. This date allows for the completion of pending transactions. If you want to own the stock and receive the dividend, you need to have your transaction through by this date. After the ex-dividend date, the market will discount the stock's price because the dividend will no longer be available to buyers.
The payment date is when the company actually mails the checks. This usually occurs two weeks after the record date.
There are two types of dividends: fixed and variable. Fixed rate dividends go to the owners of preferred stock. Common stock holders receive variable dividends.
Dividends are a great way to make money and often offer a fairly steady income if the stocks are chosen wisely. Many investors find that buying stocks with a good history of dividend payments is good for the growth of their portfolios.