What Is a Dividend?

A stock that pays a cash dividend is a real asset to the long-term investor. The cash that you receive is actual money in your hands. You can spend it, save it, buy a new investment or reinvest it in a stock that you already own. Unlike stock gains and losses that change from day to day, a dividend is yours to keep.

Here are some basics about dividends. A cash dividend is a dollar amount paid to the shareholder of a stock. Each share that you own qualifies to receive a dividend. For example, if you own 100 shares and the dividend is $1 per share, you will receive a $100 dividend. So the more shares that you own the more dividends you will receive. Most dividends are paid every quarter (three months) but occasionally a company will pay a special one-time dividend. And some companies pay monthly dividends.

You may receive the dividends in cash to spend or save at your discretion or you may choose to reinvest the dividends and purchase additional shares of stock you already own. This process is called dividend reinvestment and it is a strategy that many long-term investors employ to accumulate shares of a stock. Most companies and brokerage firms offer dividend reinvestment programs.

Reinvesting dividends is an easy way to increase the total return of an investment. In addition to getting a gain from price appreciation, you receive a gain from increasing the number of shares that you own.

Many successful companies have long histories of paying dividends year after year. And the top companies regularly increase their dividends. So you can count on receiving a reliable increasing stream of cash from these companies.

Unlike prices that go up and down and create uncertainty and angst for investors, reliable dividends are unaffected by fluctuations in stock prices. Dividends keep coming during good and bad times as long as the company remains financially healthy. Therefore, an investment portfolio that includes a large proportion of dividend-paying stocks provides an uninterrupted cash flow.

Dividend Yield

You measure the size of a dividend by its dollar amount and its current yield. The dividend amount is usually reported as the annual dollar amount. So when you read that a stock pays a $1 dividend, it means you will receive $1 a year for each share you own.

The dividend yield is the ratio of the annual dividend amount to the current price of the stock. So if the dividend is $1 and the current price is $50, the yield is 2 percent ($1/$50). But when the stock changes price the current dividend changes accordingly. So if the stock moves up to $55, the dividend yields drops to 1.82 percent. Or if the stock price falls to $45, the dividend yield increases to 2.22 percent. Buying a stock when its price is down temporarily is a way to increase the dividend yield.

Payout Ratio

The payout ratio is the annual dividend divided by the annual earnings. If the ratio is greater than 80 percent to 90 percent, the current dividend might not be sustainable. Some payout ratios are greater than 100 percent and these dividends may be very suspect. Always check the payout ratio before you buy a dividend-paying stock.

Related Articles:

Buy Stocks with Increasing Dividends
Dividends Will Reward the Patient Investor
Important Dates for Dividends
Why Dividends Matter

Updated December 11, 2007.