What Is a Dividend? Definition, Examples & Related Terms

What Are Dividends and How Do They Work?

Dividends are periodic payments made by a company to its shareholders out of its profits. Dividends are paid on a per-share basis, so the more shares a stockholder owns, the more they receive when dividends are paid out.

In most cases, companies only pay dividends when they are profitable. That being said, not all profitable companies pay dividends. In general, it is more common for older, more mature companies to pay dividends, as newer companies tend to reinvest most or all of their profits in growth and expansion.

How Often Are Dividends Paid?

Dividends are paid out regularly at particular intervals (usually quarterly but sometimes annually or monthly). How often payments are made to shareholders is up to each company’s discretion, and companies may start or stop paying dividends at will.

For example, Apple (NASDAQ: AAPL) paid dividends between 1987 and 1995, then stopped paying them for over 15 years before resuming payments in 2012. Apple’s entire dividend history can be found on its website.

Dividend Example: AAPL

The table above lists the dividends paid by Apple to its shareholders from April 20201 to August 2022. The dividend amount listed is per share, so an investor with 100 shares of Apple stock would have received $23 on August 11th, 2022. 

What Is Dividend Yield?

Dividend yield is the percentage of a company’s current share price that it pays (per share) in dividends annually. Because a company’s share price changes constantly, its dividend yield does as well. This means that if a company’s stock goes down in value, its dividend yield goes up. Therefore, a higher dividend yield isn’t always indicative of a company doing well. 

How Is Dividend Yield Calculated?

Dividend yield is calculated by dividing the amount a company pays per share annually in dividends by its current share price. For instance, if a company pays a dividend of $.50 per share quarterly, and its current share price is $50, then its dividend yield is .04 or 4% because (0.50 * 4) / 50 = .04, which equates to 4%.

Dividend Yield Formula

DY = Dividends Paid per Share Annually / Current Share Price

What Is a Dividend Payout Ratio?

A company's dividend payout ratio is the percentage of its annual earnings (profits) that are paid out to shareholders as dividends. Because it compares a company's dividends to its total earnings instead of its current stock price, many investors consider the dividend payout ratio a more stable and informative measure of the degree to which a company prioritizes dividend payments.

Dividend Payout Ratio Formula

DPR = Total Dividends Paid / Net Income

What Is Dividend Investing?

Dividend investing is an investment strategy that is popular with folks who want a passive income stream to supplement (or in some cases, replace) their regular income. It involves investing in companies that are known to pay dividends in order to collect income passively on a regular basis. All of the dividend payments an investor receives are in addition to any increases in portfolio value they may experience as the stocks they own go up in value over time.

This is typically a longer-term strategy because dividend investors must hold the stocks they own for substantial periods of time if they wish to continue receiving regular payments. That being said, a savvy dividend investor might unload certain stocks in order to buy others that pay higher or more regular dividends.

Since dividend yield—even for stocks known to have high dividend yields—is rarely above five percent, investors usually need to put in a substantial amount of capital in order to create lucrative passive income streams using this strategy.

What Types of Companies Pay the Highest Dividends?

Many different types of companies pay dividends, and dividend payments vary over time, so it’s always important to conduct research in order to determine what stocks best fit your dividend investment strategy. That being said, the following sectors and industries tend to boast a variety of companies known to pay consistent and substantial dividends.

• Utility companies
• Telecommunications companies
• Energy companies
• Chemical companies
• Regional and money center banks
• Real estate investment trusts

Can You Live Off Dividend Income?

Creating a portfolio that allows you to live off dividend income is no easy task, and doing so successfully requires a lot of capital. In order to determine how much money you would need in order to live off dividends, you must first determine how much income you need per year and what dividend yield you think you might be able to realistically achieve. Divide the annual income you require by the dividend yield you think you can get to find out how much money you will need to invest.

For example, if you need $50,000 per year in income, and you’ve identified a pile of dividend stocks (or a dividend stock ETF or mutual fund) that will land you a 3% yield, divide 50,000 by 0.03. The result is $1,666,666.66. In other words, you would need to invest over 1.5 million dollars and get a 3% dividend yield in order to receive $50,000 in passive income per year. So, unless you have plenty of capital at your disposal, supplementing your income with dividends may be more realistic than replacing it with dividends. Of course, in any dividend-investing scenario, the capital you invested initially would still be yours and would likely grow over time.

What Do Ex-Dividend Date and Record Date Mean?

The ex-dividend date is the date on or after which any buyer of a stock is not eligible for the most recently declared dividend. The date of record occurs the next business day. On the date of record, a company examines its records to determine which shareholders owned the stock before the ex-dividend date and are therefore eligible for the dividend payout.

Put simply, an investor must have bought a stock at least one business day before the ex-dividend date and at least two business days before the date of record in order to be eligible to receive the most recently declared dividend payment.

How Is Dividend Income Taxed?

Dividend payments are taxed as income unless they come from stocks held in accounts with special tax features like 401(k)s or IRAs. Ordinary dividends are taxed at the same rate as normal income. Other dividends—known as qualified dividends—are taxed at a lower rate than normal income.

What Are Qualified Dividends?

In order to be qualified, a dividend must be from a U.S. company (or a qualified foreign firm) and the parent stock must have been held for a minimum of 61 days out of the 121 days that began 60 days prior to the ex-dividend date. Certain dividends may be disqualified because they fall into special categories (e.g., they come from a tax-exempt organization or from an employee stock plan).

For more information on how dividends are taxed, visit the IRS website.