What is a Dividend?
A dividend is a distribution of a company’s profit to its shareholders. This distribution can take form in either cash or additional stock. The amount is typically decided by the board of directors, and varies depending on the company. Dividend is typically distributed once every quarter.
Some companies pay dividend, some do not:
- Mature companies pay dividend because investors like the steady income that dividend gives them. Dividend is also a sign that management has a positive outlook on the company.
- Growth company does not typically issue dividend. This type of company reinvest its profits for further growth, instead of distributing them into dividend. This is because the management of growth companies believes that investing for future growth would give higher return on investment. As more investment into the business is made, revenue of the company grows, and stock price will increase. Occasionally mature companies may decide not to issue dividend, and use that cash flow for various projects, such as acquiring new assets or M&A activities. The decision to start paying dividend or to increase existing dividend is a serious one. It is very difficult for a company to reduce or stop paying dividend. Reversing the amount of dividend signals the market that the company’s prospect is unhealthy.
For example, Apple, as a mature company, typically pays out a dividend yield of 1â€“2% of the stock price. In contrast, Twitter or Tesla, as growth companies, do not pay dividend. Generally, companies in the following sectors and industries have among the highest historical dividend yields: basic materials, oil and gas, banks and financial, healthcare and pharmaceuticals, and utilities.
The benefits of Dividend
Dividend is important for long-term investment. When you receive stock dividend, you can keep the additional stocks and grow your investment in the companyâ€Šâ€”â€Šwithout incurring taxes. Or alternatively, when you receive cash dividend, you can reinvest the cash by investing into a new company, diversifying your portfolio. Over long periods, the returns from dividend will compound to give an outsize return.
The downside of cash dividend investing is the tax consequences. Cash dividend distribution is taxed as regular income at the moment of issuance. Hence, you do not benefit from the lower capital gain tax rate. Meanwhile, there is no taxable event when investors receive stock dividend; taxes are incurred only when the stock dividend is sold. If you are an investor from India, and are interested in learning more on how dividend works for US investments, visit our FAQ page.
Thanks for reading! Remember that there are three keys to becoming a successful investor: keep investment costs low, diversify your investments broadly and do not chase performance.