What are dividends?
A dividend is money paid regularly by a company to its shareholders, usually as a distribution of profits. Dividends can be issued as cash payments, shares of stock, or other property.
A company’s net profits can be distributed to shareholders as dividends or kept within the company as retained earnings.
Who pays them?
Companies that pay strong dividends are often the more mature, established, and well-known brand names, such as:
- Johnson & Johnson
- Procter & Gamble
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Why issue dividends?
Many investors like having the steady income associated with dividends, so they will be more likely to invest in a company that issues them.
Investors also see dividend payments as a sign of a company’s strength. If a company has a history of past payments, a decrease in the amount may indicate that the company could be in trouble. An unexpected increase in the rate, however, might be a positive signal to the market.
Younger companies that are still growing may choose not to pay dividends because they want to invest as much as they can for future growth. Companies that don’t pay dividends can use that money to:
- Start a new project
- Acquire new assets
- Repurchase some of their shares
- Buy out another company
Dividends allow investors to get cash out of the market without selling stock and paying excessive trading fees, which is especially beneficial during retirement years when investors want to continue to generate income from their portfolio.
Dividend tax rates
Qualified dividends, such as most of those paid on corporate stocks, are taxed at long-term capital gains rates, which are lower than ordinary income tax rates. Nonqualified dividends, however, are taxed at the higher ordinary income tax rates.
Companies that issue dividends can distribute them in numerous ways:
- Stable dividend policy—maintains a steady dividend payout
- Constant payout ratio—pays out a specific percentage of its earnings each year as dividends
- Residual dividend model—based on the amount of residual earnings left after the company pays all its expenses and obligations
The board of directors decides the amount and timing of the dividend.
- Japan offers the lowest dividend tax rate of just 10%, while France taxes payouts the hardest at around 40%. Iran does not tax dividend income at all.
- Apple, which holds the record for the highest market valuation in history, only began paying a dividend in 2012, after a 17-year dividend hiatus.
- An exclusive club called The Dividend Aristocrats Club consists of companies that have raised their dividend for 25 or more consecutive years. Fewer than 100 companies are in the club.
- Although approximately 92% of Warren Buffett’s portfolio is invested in dividend stocks, he has maintained a strict no-dividends policy for Berkshire Hathaway. The company has paid only one dividend, in 1967, which he jokes he “must have been in the bathroom” when the decision was made.