What are dividends — and how do they work?

Investing can be quite an adventure, especially when you're first starting out. You'll learn about all kinds of things, like the stock market, risk tolerance, and portfolio diversification. Grasping the key concepts of investing early on will make your investing journey easier. One such concept is dividends.

A dividend is a portion of a company's profits given to each shareholder at the end of an earnings period. So, an organization with a positive net income for the quarter or year might share some of its income directly with stockholders. The more shares an investor has in the company, the more they'll receive in dividends.

Think of dividends as a financial reward for investing in a company. You can use the dividends you receive toward something you want (like a night on the town) or reinvest them in new shares. 

Everything you need to know about dividends

Here are a few common questions new investors have about dividends — and their answers!

What are the types of dividends?

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There are five main types of dividends you may come across as an investor: cash, stock, dividend reinvestment programs, special dividends, and preferred dividends.

Cash dividends are the most common. A company that declares a cash dividend will pay individual payments to each shareholder, which goes to their brokerage account. You can use cash dividend payments for reinvestment or to buy something you want. So, if you own two shares in a company and it issues a $1.00 dividend, you’d find an extra $2.00 in your account!

Stock dividends reward shareholders with additional shares of stock. The company might issue one new share of stock for every shareholder who meets certain requirements, such as owning a specific number of shares in the organization. For example, if you already own three shares of stock in a company and it issues a stock dividend of one extra share, you’d now own six shares in total.

Some companies offer dividend reinvestment programs (DRIPs), which shareholders can opt into. If the company issues a dividend, DRIP subscribers will see their earnings go toward new shares in the business. You won’t receive any extra cash.

A special dividend may share similar features as a cash or stock dividend, but it's usually a one-time deal. It doesn't recur like quarterly or annual dividends might. Companies might issue a special dividend after a major organizational shakeup, such as a merger, or if they have significant cash reserves that aren't needed for operations.

Finally, preferred dividends go to investors who own preferred stock. Some preferred stocks set fixed dividends that shareholders receive at certain time frames, such as quarterly or annually.

How are dividends distributed?

There are a couple of factors that impact dividend distributions. They include the company's profits and the number of shares you own. 

If the company doesn't earn a profit for the period, it probably won’t issue a cash dividend. However, it may issue some other type of dividend, like a stock dividend, to keep shareholders interested. 

If the company earns a profit, management may allocate some of the earnings to dividends and retain the rest. For instance, it might distribute 20% of earnings and keep 80%. The 20% allocated to shareholders is known as the dividend payout ratio.

Typically, shareholders will receive dividends through their investment accounts. Some companies will issue you a check for your dividends if you ask them to.

What is dividend yield?

Some investors follow a dividend investing strategy, which involves buying stocks, mutual funds, or exchange-traded funds (ETFs) that historically issue dividends. They may reinvest their dividends into new shares, which helps build wealth over time. Using the dividend yield ratio, you can measure the results from a dividend growth investment strategy.

The dividend yield ratio is a simple measurement that indicates your average dividend yield from every dollar you invest in different assets. To calculate it, simply divide the dividends you received for a period (such as a year) by the price per share.

So, assume you bought one share of stock for $40. Over the year, you received $4 in dividends for your share. The dividend yield would be 10%, or $4 ÷ $40. 

The higher your dividend yield is, the less time it will take to recover the value of your initial investment (not considering any gains in stock price). 

Who is eligible to receive dividends?

To receive dividends, you must own shares in a company, mutual fund, ETF, or other investment asset that issues them. If you're not a shareholder, you can't earn dividends. 

The date you buy your shares can also impact your dividend eligibility. Companies use a cutoff date to decide who gets a dividend and who doesn't. That's the ex-dividend date. If you buy your shares after the ex-dividend date, you won't receive a dividend for the earnings period.

All companies, mutual funds, and ETFs have different dividend policies. Some may issue regular dividends, while others may not.

How to choose the right type of stock to invest in

There are many approaches to picking stocks. Some people buy stocks based on technical indicators, like historical performance or share trading volume. Others look for safe investment options, like compound interest accounts. And some buy stocks because they like the products or services a company sells or believe in its mission. 

Decide what matters most to you when determining your investment plans. You can always start small and invest more as you become more confident in your investing decisions. Some platforms (like Greenlight’s investing app) allow you to propose to buy fractional shares at an amount you're comfortable with — such as a single dollar!

Make your money work for you with stocks that pay you back

If you want to learn more about investing, consider the Greenlight app. Through Greenlight, you can access lots of educational tools, including videos and stock research, to learn more about investing and how it works. Plus, Greenlight allows you to put your skills to work and propose to buy fractional shares in companies you're interested in for as little as $1. Start today, and empower yourself for the future!

Please note: All investing accounts set up within the Greenlight app are brokerage accounts in the Primary Account holder’s name. For more information, click here.