Dividend stocks are stocks that pay out a portion of the company’s earnings to shareholders as dividends. The regular dividend payments provide an attractive income stream in addition to the opportunity for stock appreciation.
But what exactly are dividend stocks, how do they work, and what should investors know about them?
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Definition of a Dividend Stock
A dividend stock is a stock from a company that agrees to consistently share a portion of its profits with its shareholders in the form of dividends. These regular cash payments are typically made on a quarterly basis.
The size and frequency of dividend payments vary greatly by company, but the concept remains the same – sharing profits with shareholders.
How Dividends Are Paid Out
When a company generates profits, its board of directors can choose to reinvest some or all of the earnings back into the business. Any remaining profits can be distributed to shareholders in the form of dividends.
Some key aspects about how dividends work:
- Dividends are usually paid per share, not as a percentage
- Companies set a “record date” determining which shareholders will receive payment
- Dividends are considered taxable income for the year paid
- Dividends can be paid in cash or as additional shares
Shareholders must own the stock prior to the record date to qualify for the upcoming dividend.
What Types of Stocks Pay Dividends?
While any company can choose to pay dividends, they most commonly come from:
- Large “blue chip” corporations
- Companies with slower growth
- Firms in strong financial shape
- Businesses in non-growth industries
- Real estate investment trusts (REITs)
Established, profitable companies are best positioned to share consistent dividends.
Benefits of Dividend Stocks for Investors
Key benefits dividend stocks offer investors include:
- Passive income from regular cash dividends
- Dividend reinvestment allows compound growth
- Added return on top of stock appreciation
- Indicator of earnings and financial health
- Less volatility than non-dividend stocks
The twin returns from dividends and stock growth lead many investors to favor dividend stocks for long-term portfolios.
FAQs About Dividend Stocks
How are dividends taxed?
Dividends are taxed at either short term capital gains rates or lower long term capital gains rates based on holding period.
What dividend yield is considered good?
Aim for dividend stocks yielding 2-6%. Yields above 8% could signal high risk. Average S&P 500 yield is 1-2%.
Do all dividend stocks pay quarterly?
Most pay quarterly but frequency varies. Some monthly, semi-annually or even annually. Quarterly dividends are most common.
How do I find dividend stocks to invest in?
Screen for stocks with increasing dividends over time. Research company financials for safety. Diversify across sectors and yield ranges.
Are dividends guaranteed payments?
No, dividends can be reduced or eliminated at any point depending on company performance and board approval. But they aim for steady increases.
Dividend stocks provide recurring income through reliable dividends in addition to potential share price appreciation over time. Understand how they work before investing.