At some point during your investment career, you will surely hear about dividend stocks. But, when that time comes – if it hasn’t already – will you understand the importance of dividends and how they could possibly affect your investment portfolio? Will you know what it means for a company to offer dividends to its investors and the reasons why a company might choose to do so? Of course, you will! Why? Because we are here to help educate you. This article will explain all the ins and outs of dividends so that you will be able to use your knowledge to make informed investment decisions in the future.
Let’s start with the basics. What actually is a dividend? When investors reference dividends, they are talking about cash payments that some companies make to their stockholders – like you! These cash payments come out of the company’s earnings. Periodically, the number of the company’s earnings that is distributed to stockholders will be determined by the company’s directors, ensuring that it can pay out its stockholders over time. This method of shareholder payment comes from the idea that investors become part-owners in a company once they buy shares in it, so they should be paid out when the company makes earnings.
One nice thing about dividends is it they are one of the only forms of payment that allows an investor to profit from his or her investments without selling any shares of the company. But, because paying dividends is not something that all companies do, we as investors must ask: why do some companies decide to pay dividends to shareholders? Furthermore, how can companies afford to pay investors before they sell their shares?
These are some of the most common questions about dividends. First, let us start with a hypothetical company that has made profits in the past year from its operations. When that company realizes a profit, its management can decide either to reinvest this profit – with the hope of making more profit in the future – or to distribute some of its earnings back to shareholders in the form of dividends. How does a company make this decision? Typically, a company will look at its annual rates of profit. If the company is growing at a very large rate, it may decide to reinvest its money rather than paying dividends, because it would hope to continue growing in that way. Of course, a company that is performing very well may also decide to pay dividends to its shareholders because it can afford to do so and wants to keep them happy. The company would hope that by paying dividends, it would achieve investor loyalty and encourage its investors to put more money into the company.
On the other hand, if the company’s growth is slowing down for a period of time, it may decide to pay out its shareholders in dividends – but for a different reason. While these payments will also make investors happy, the company might hope that paying its shareholders will incentivize them to hold their shares in the company, even if the stock’s performance is below average for this period of time. Similarly, a company that is performing poorly may also want to retain its earnings and reinvest them, with the hope of turning things around. By reinvesting in other things, the company may be able to stabilize itself and increase its rates of profit.
From all of these reasons, you can see that there are a variety of motives that may move a company to start paying out dividends – or lead it to decide not to do so. But, what can you do with this knowledge? As a shareholder in any company, you may want to start by looking at a company’s profit ratios in order to better understand its motivation and payment structure – even if the company’s dividends look promising right off the bat. Remember that not all companies pay dividends and that, while dividends can be very good for investors, a company that is not paying dividends may also be a great investment choice. However, if you find a promising company that is paying dividends, you might evaluate that fact as an important factor in making your investment decision!