A dividend is an income-like payment to an investor who holds stock. Dividends tend to be paid by companies who are well established and are not retaining their earnings for capital projects.
There are several kinds of dividends, but the most common is the cash dividend. You are not likely to see dividends paid by companies whose stocks are categorized as Growth stocks.
Growing companies are going to be ploughing money back into their company for years. Well-established companies tend to distribute some of their profits as dividends because it allows them to retain loyal shareholders and keep the price of the stock fairly steady.
Companies care about the price of their stock, even though they’ve already gotten all of the outright capital out of them when they originally issued them, because the shares are a kind of currency to the company for employee equity incentive programs as well as for acquisitions where their stock might be exchanged for that of another company — and, on the flip side, a respectable stock price can also make it harder for other companies to buy controlling interest in the company.
Dividends are paid out of profits instead of saving the money for other sorts of projects. Too much cash on hand can cause companies to be taxed more than is necessary by state franchise taxes and whatnot. Dividends are generally cash payments to investors based on the number of shares they own.
Dividends can be in the form of more shares of stock, or of a stock repurchase which reduces the number of shares in circulation and raises the share price of each. There are other forms of dividends, but they are not nearly as common. A typical dividend of an S&P 500 company might be worth 2% of the share price.
Different kinds of companies and investments will be expected to pay higher or lower dividends. Partially this has to do with the required yield, or how much investors will expect to be paid for the amount of risk involved. Interest paid on bonds are called dividends, too.
High yield corporate bonds, for instance, tend to pay around 6% or more, because the companies have lower credit ratings and they have to give an incentive to investors to purchase the bonds. REITs are known for high dividend payouts that are based on the income generated from real estate investment properties.
In this section, we will mostly focus on stock dividends.