Dividends

Sharing the pizza money

This year Sunny Slice made $1.5 million of profit. It has 1,000,000 shares, so that's $1.50 of profit for each share.

The company has a choice. It can keep the money to open new shops, or it can hand some to the owners. Sunny Slice does both: it pays $0.60 per share as a dividend and keeps $0.90 to grow.

Most US companies that pay dividends pay every three months, or every quarter. So Sunny Slice pays $0.15 per share, four times a year. If you own 100 shares, you get $15 every three months, or $60 a year.

Dividend yield

How big is that dividend? Compare it to the price. That's the dividend yield:

Yearly dividend ÷ price = $0.60 ÷ $30 = 0.02, or 2%.

It's a bit like the interest on a savings account, except it's not promised. The yield also changes when the price changes. If the stock falls to $20 and the dividend stays $0.60, the yield becomes 3%.

The part of profit a company pays out is the payout ratio. Sunny Slice pays $0.60 of its $1.50, so its payout ratio is 40%.

Who pays and who doesn't

• Older, steady companies often pay dividends: soda makers, power companies, big banks. Coca-Cola has raised its dividend every year for more than 60 years in a row.
• Fast-growing companies often pay nothing. They put every dollar back into growing, hoping the price rises instead. Many big tech companies paid no dividend for years.

Neither is better. They're just different deals.

The cutoff day

To get a dividend, you must own the shares before a cutoff day called the ex-dividend date. Buy on that day or later, and that payment goes to the person who sold to you.

Here's the part many beginners miss: on the ex-dividend date, the price usually drops by about the dividend. If the stock is $30 and pays $0.15, it often opens near $29.85. The money just moved from the company's pocket to yours. A dividend isn't free money. The real value comes from the company earning it again next quarter.

Reinvesting

Many people use their dividends to buy more shares automatically. More shares means a bigger dividend next time, which buys even more shares. That's compound growth, the snowball from Money Basics. Over long stretches of history, reinvested dividends have been a big part of what stock owners earned.

What goes wrong

• A super high yield can be a warning. If a stock suddenly yields 12%, ask why. Often the price crashed because the business is in trouble, and a dividend cut may be next.
• Dividends can be cut. In 2020, when the virus closed stores and stopped travel, many companies cut or paused their dividends.
• Paying out more than you earn can't last. A company with a payout ratio over 100% is paying owners with money it didn't make.

Remember

• A dividend is part of the profit paid to owners, usually every three months.
• Dividend yield = yearly dividend ÷ price.
• On the ex-dividend date, the price usually drops by about the dividend.
• A very high yield can be a warning sign, not a gift.