Personal Finance
Lesson 14
3 min

What is a dividend?

When investors buy stock or a share of a company, they expect to receive payments in return, which are called dividends. These payments are part of the company's earnings which they distribute to investors in return for investing in their company. 

  • Dividends are earnings on stock investments

  • There are three types of dividend payment: residual, stable and hybrid

  • The board of directors of the company decides on the amount of dividends paid and at what intervals

  • Dividends reflect positively on a company and are among the reasons why an investor would choose to buy stocks from a company

In this lesson, you are going to learn about the basics of dividends.

When an investor buys shares in a company, they expect to get reimbursed in return. The distribution of dividends is up to shareholders of a company and ultimately decided by the issuing company’s Board of Directors. 

Why do companies pay dividends?

Dividends represent the distribution of a share of the company’s profits from the company to their shareholders in order to reward investors for their investment and incentivise them to keep holding their shares. 

Dividends reflect positively on a company. On the one hand, investors buy shares because they expect the value of a company’s stocks to increase over time, on the other hand, they buy shares to receive annual or quarterly dividend payments in return for their investment.  

Are investors entitled to dividend payments?

Dividends provide investors with additional income. However, shareholders are not entitled to dividend payments, as it is up to the issuing company whether to distribute dividends, depending on factors such as positive company performance, plans that require a company to reinvest all earnings for future growth, and others.

Dividends represent the distribution of a share of the company’s profits from the company to their shareholders in order to reward investors for their investment. 

How much in dividends do companies pay?

Stock dividends are paid to shareholders depending on the number of shares they hold in a company. Dividends are usually paid once a year, sometimes on a quarterly basis, meaning four times a year. A healthy percentage of profits used by a company for dividend payment is about 35% to 55%. 

The exact percentage of profit a company distributes to its shareholders is determined at the annual general meeting all shareholders are entitled to attend. At the annual general meeting a company also presents its financial statements and elects the Board of Directors for the year ahead. If an investor’s shares are being held in a custody account with a financial institution, the custodian bank takes care of dividend settlement. Distribution of profits to shareholders usually takes place one day after the annual general meeting.

What is a stock dividend?

Companies issue stock dividends (additional shares to shareholding investors) when they decide not to issue dividends in the form of cash but still want to reward investors.

 
 
 
 

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There are three main types of dividend policy that determine the way a company distributes dividends to its shareholders.

Residual dividend

Companies sometimes rely on internally-generated equity to pay for new projects related to the company. This means that a company wants to invest a large part of earnings for future company projects or other ventures. Therefore a company board may decide not to issue regular dividend payouts, instead calculating their earnings before distributing dividends to shareholders. As a result, the amount of dividends paid to shareholders depends on the amount of earnings that remains - hence “residual dividend” -  and consequently payments will vary each year or each quarter.

Stable dividend

This is exactly how it sounds: the company pays regular and predictable dividends to investors on their agreed-upon dates. This is good for investors as it provides them with a stable and trustworthy income and is, for this reason, the most sought-after type of dividend.

Hybrid dividend

This policy combines residual and stable dividend payments. The company establishes a regular dividend payment annually or quarterly that investors are able to rely on. In addition, if corporate performance reaches a certain level, a special dividend payment is issued to shareholders in addition to stable dividend payments. 

Do shareholders have a say?

As you learned in lesson 11 of the personal finance section, common shareholders have voting rights at the annual general meeting regarding decisions of a company. When voting for or against the distribution of dividends, voting shareholders need to bear in mind that a dividend payment does not only affect investor income but also company profitability.

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