How Do Dividends Actually Work?

If you’re here reading this, you likely know what dividends are. Do you know, however, about the dates involved with dividend payments? Do you know how a stock’s price is impacted when a dividend is paid? Let’s dive in!

dividend calculator

I can get paid just because I own a stock?

Yes, you sure can.

“A dividend is the distribution of some of a company’s earnings to a class of its shareholders…”

— Investopedia

Not all companies pay dividends, but those that do are essentially sharing some of their profits with you in exchange for the capital you are providing by owning their stock. Pretty cool!

There are a few instances where dividends are not paid on a regular basis (if company has a particularly strong quarter or year they may offer a one time dividend to celebrate). For the most part, however, companies that pay out dividends do so on either an annual, quarterly, or monthly basis.

** Something important to keep in mind, the dividend per share figure that you see on stock quotes (Yahoo Finance, your brokerage etc.) are almost always quoted on an annual basis. The dividend yield % is too. **

You said something about dates, expand on that please?

Yup. Dates. There are a few of them:

  • Declaration date

  • Ex-dividend date

  • Record date

  • Payment date

Declaration date

This is the date that the company announces that they will be paying a dividend. Sometimes it is known as the announcement date, but announcement dates happen every time a company announces something. This is more specific. They go over all the important details at the meeting on this date including the size of the dividend, the ex-date (see below), and paint a clear picture of what they would like to happen. Note, shareholders have to vote to approve this.

Ex-dividend date

Arguably the most important date here. If you buy a stock on or after this day, you do not get the upcoming dividend. As mentioned above, this date is set at the declaration event. You have to have purchased your share(s) at least one business day before this date to get the dividend.

Example: If October 27th is the ex-date, I would have to buy the share(s) on or before October 26th in order to get the dividend.

Record date

This usually happens one day after the above. On this day, the company makes note of all current shareholders who will be receiving the dividend payment. If you really want a dividend, make sure you buy your share(s) at least two business days before the record date.

Payment date

Pay day doesn’t need an explanation! If someone tells you that dividends are too small to matter, slip $10 in their pocket and see how they react when they find it!

That’s awesome! Free money, right?

No such thing as free money, my friend. In almost every case (I’m sure there are exceptions), the stock’s price lowers by the amount of the dividend at the open on the ex-dividend date. If you know anything about stocks and their prices, things don’t stay in one place for long, though.

The good news? The stock’s price almost certainly got a nice bump on the declaration date (the first one above), probably to the tune of roughly the amount of the dividend that will be paid.

Another example: If a company pays quarterly dividends and the quote I just looked up says that they pay $4 in dividends, the dividend per share will be $1 this time. The above movements in share price, at least the movements caused by the dividend itself, will likely be in the amount of roughly $1.

So if it all evens out, what’s the point?

Well, that’s a pretty good question. There are a few points.

Point 1: If you are doing your research and investing in solid companies, the dividend payments really are a share of the profits and the stock’s price should theoretically go up in the long haul.

If, as a smart person, you are reinvesting your dividends and ultimately acquiring more and more stock, you should see some healthy gains! Plus, if a company is doing well enough to share some of its profits with you, they’re probably healthy, right?

** A quick note, do not let yourself get caught up hunting for the highest dividend yields you can find. It is not unheard of for a company with poor leadership to continue paying a dividend that they can no longer afford to pay out to avoid looking bad. This will always catch up to them and can result in some pretty significant issues including a tanking stock price. **

Point 2: Perhaps you are retired and rely on your investments for income. Dividends can provide some pretty nice cash flow. These numbers might seem large, but in retirement they are fairly realistic.

A $1,000,000 stock portfolio with holdings that average a 4% dividend yields you $40,000 in dividends each year simply in exchange for owning the stock. Not so bad! Want to take this a step further? Check out this article on qualified dividends to see some super cool tax hacks!

Point 3: While I prefer to advocate the long term and easy going buy and hold investing strategy (learn a thing or two about index investing here), there is such a thing as a dividend capture investing strategy. I won’t go too far into it, but knowing about the price movements I mentioned above can make for a nice income based trading approach (probably best for more experienced investors).

Read more about it here!

I hope you enjoyed this one and learned a thing or two! If you ever have any questions, suggestions, thoughts or whatever, please do not hesitate to reach out to me!

My contact information can be found here!


Leave a Reply

Your email address will not be published.