A dividend payment is the distribution of a company's profits to its shareholders. Dividends are usually paid in cash, but sometimes in company stock, and companies often use them to return profits they don't need for their operations back to investors.
Beyond that basic definition, there are a number of important questions about dividend payments that investors should know the answers to.
- How do companies decide on dividend payments?
- How do stocks pay dividends?
- When do stocks pay dividends?
- How do you get dividend payments?
- What is the average dividend payment?
How do companies decide on dividend payments?
In general, a company's board of directors is responsible for its dividend policy and determining the size of a dividend payment. Depending on a company's growth goals, industry, and other factors, the board will determine an appropriate dividend payment.
This can vary from one industry to the next and among companies in different growth phases. Industries that are lower growth but generate stable earnings and cash flows, such as utilities companies, often prioritize higher dividend payments to attract investors. Companies in sectors that are more cyclical, like consumer discretionary goods, may pay a lower portion of their earnings as dividends, prioritizing their ability to maintain the dividend payment when business is weaker.
How do stocks pay dividends?
Whether your interest in dividend stocks is as a source of income or for more cash to reinvest in your stock portfolio, it's important to know how a company pays a dividend. The short answer is that a company pays a dividend out of its earnings. When a company earns a profit, it has essentially three things it can do:
- Invest it back into the business (build a factory, expand into a new market, make an acquisition, pay off debt, etc.).
- Retain it for a future need.
- Return it to shareholders by repurchasing stock or paying a dividend.
In a broad sense, if a company doesn't have a clear internal use for its excess profits, returning them to investors by paying a dividend is ideal.
A company that doesn't generate regular or consistent earnings, or is not yet profitable -- like many start-ups or high-growth companies that are aggressively spending to grow their operations -- may not be able to pay a dividend. These companies have better use for their earnings, or simply don't generate enough earnings to afford a dividend.
In a few rare instances, a company may pay dividends in stock, not cash. While it's rare, it's important to make sure you know whether this is the case, especially if you're counting on those dividend payments for income today.
When do stocks make dividend payments?
The vast majority of dividend stocks pay dividends quarterly, though there are some companies that make dividend payments monthly, and a very small number that make annual and semiannual dividend payments.
Determining when each stock you own will pay dividends is relatively easy. When a company's board of directors determines the next dividend, it will declare the dividend, typically in a press release or a filing with the Securities and Exchange Commission, or SEC. This release will disclose the amount of the dividend, the dividend payment date, and the date you must own shares by to get the dividend payment.
How do you get dividend payments?
While some investors own stocks in company-sponsored direct stock purchase plans and receive the dividend directly from the company, the vast majority own stocks through a broker. In this case the dividend payments come to your brokerage and are deposited in your brokerage account.
For this reason, your dividend payment may not show up in your account on the payment date in the company's release declaring it -- it could be a day or two before the money shows up. This is particularly important if you are counting on those dividend payments for income, since you may need to allow for a few more days to transfer the cash from your brokerage account into your checking or savings account.
In those rare instances when a company makes a dividend payment in company stock, it will take even longer to get cash if you own the dividend as a source of income today. You'll need to sell the shares, then wait a couple of business days for the trade to settle before you can initiate the cash transfer. Make sure to plan accordingly.
What is the average stock dividend payment?
This can vary greatly from one industry to the next, and even from one stock to the next in similar industries. But as a starting point, we can use the S&P 500 Index (SNPINDEX:^GSPC). This index, which tracks just over 500 of the largest U.S. publicly traded companies, makes up about 80% of the market cap -- the dollar value of a company's stocks -- of the entire U.S. stock market.
Here is the average dividend yield -- the annualized dividend payment as a percentage of the recent stock price -- of the S&P 500 over the past decade or so through Sept. 16, 2020:
As you can see, it can fluctuate significantly from one period to the next, with the dividend yield falling in the second half of 2020 because of the rebound in stock prices and because many companies cut their dividend payments due to the deep recession.
Individual industries, such as utilities and real estate, often pay higher dividends due to the stability of their revenues and their slower rate of growth, while more volatile industries, such as consumer discretionary goods and technology companies, generally pay much smaller dividend payments, as seen below.