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What Are Dividends?

August 25, 2011
Don G. Mehling, CFA

Dividends are taxable payments to shareholders from a company’s earnings. These payments generally come from profits and tend to be distributed in the form of cash or stock. They are usually paid quarterly, and the amount is determined by the company’s board of directors.

Dividends are most often quoted by the dollar amount each share receives; put simply, the dividends per share. They can also be stated in terms of a percent of the current market price, designated as a dividend yield. The dividend yield is the annual dividend income per share divided by the current stock price. When calculating the dividend yield on stock you already own, divide the current dividend amount by the price per share you paid for the stock. This calculation tells you what you are earning on your investment on an annual basis from the dividend income.

Many mature, profitable companies offer regular dividends to shareholders. But it’s important to remember that a company can increase, decrease or stop paying dividends at any time.

Rather than pay dividends to shareholders, many companies with current high growth rates choose to reinvest earnings back into their businesses. Alternatively, some stable companies that haven’t experienced much growth might pay dividends to provide an extra incentive for investors to purchase their stock. Because payouts have become more attractive to shareholders, even companies with high growth rates are offering dividends today.

Before 2003, dividends were taxed at ordinary income tax rates reaching as high as 35 percent. But as a result of changes to the tax law, qualified corporate dividends are currently taxed at a maximum rate of 15 percent; this lower rate will expire at the end of 2012 unless Congress acts to extend it. Dividends received in a tax-deferred account, such as an IRA, are not taxable until withdrawal, and then at ordinary income tax rates. Dividends received in Roth IRAs are never taxed, once you meet the five-year holding period and reach age 591/2.

Dividends are an important part of the total return earned on an investment, and should always be considered.

 
 
 

 

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