Dividends are profits paid to the shareholders. The goal of dividends is to attract traders; you could see dividends as a reward for people who hold the company’s stocks long term. Sometimes companies don’t payout dividends, and instead the entire profit is used to offset losses or invest in development.
Why are dividends used?
Shareholders are co-owners of the company and thus they have a certain stake in the company. As a reward for sharing in the company risks, shareowners receive a payout that corresponds to the number of shares they own and the profit made by the company. A company will never payout the full amount of profit in dividends as growth and investments are a huge chunk of the costs of a company.
For a lot of companies, it is essential to payout dividends on a regular basis. Without dividends, it’s less attractive to buy the company’s stocks for the long term and people will be more inclined to sell, causing the stock to lose its value.
How is the payout of dividends determined?
The amount of the dividend that is paid out is determined by the board of directors, but it needs to be approved at the shareholders meeting. It is possible to receive your dividend in money (cash dividend) or in the form of more stock (stock dividend). The payout of the dividend is usually absolute, but can also be relative (a certain percentage of the profit).
It’s also possible that the company will never pay any dividends. Large companies that see the price of their stock go up every year don’t have any reason to pay dividends. For example, companies such as Apple and Google don’t pay dividends. The amount that you get as a shareholder is also dependent on the type of stock you have; priority stock or preference stock can have different payout percentages.
Influence of dividends on the price of stocks
The payouts of dividends have an effect on the price of a stock. On the so-called ex-dividend dates it’s determined who owns stocks and who has the right to receive dividends. After it’s determined who gets what, the price usually drops tremendously; the drop in price usually correlates to the value of the dividends. Taxes that influence the actual amount of the dividends limit the decrease in stock price.
Investing for dividends
Receiving dividends is another way of making money by holding stocks. Despite a decreasing stock price, it is still possible to make money from your stock. Especially when you hold stocks for a few years on a special account, the dividend will carry forward to a positive return.
It is also possible to make money in the short term through dividends. When you trade CFDs, you can purchase the stocks using leverage before the ex-date, so you get dividends for all the stocks that you’ve purchased. A downside is that the price of the stock usually goes down afterwards, but with a good stop loss you can still make a lot of money this way.