Dividends: The glorious harvest of the stock market

What are earnings?

Before understanding dividends, we need to talk a little bit about earnings. A company’s earnings is basically the final profit it has left over after all expenses are paid. For example, a company that generates $1,000,000 in sales per year, and has to pay $600,000 in costs would have earned a net profit of $400,000.

There are many things the company can decide to do with this profit. More often than not, what a company does is reinvest its earnings back into the business to fuel future growth.

Let’s say that of this $400,000, the company decides to reinvest half into the company. That leaves us with $200,000 in profit (or earnings)

What is a dividend?

The second most common decision a company can take in managing its profits is redistributing them amongst its loyal shareholders.

If the company above has 100,000 shares owned by random strangers like you and me, then this $200,000 could be shared amongst us, netting a total of $2 per share ($200,000 divided by 100,000 = $2).

In our post about companies, we briefly explained how investors who own stock in a company, get rewarded for their investment in that company through a profit sharing mechanism. This exact process & calculation above is what is commonly referred to as a dividend.

When is a dividend paid?

Dividends can be paid according to predefined schedules. Each company has its own publicly announced and listed dividend schedule. You can check out sites like dividend.com to research the dividend schedules of various companies. The most common dividend payout schedules are monthly, quarterly (4 times per year), or yearly.

How is a dividend calculated?

Dividends can be expressed in one of two ways:

1. Dollar amount: How much money each share receives on the payout date
2. Dividend yield: The dividend payout expressed as a percentage of the current price per share

For example, say a company’s share price is $150 (costs you this much to own one share) and pays a dividend of $3 per share every year. It would have a dividend yield of $3 / $150 = 2% per year.

How and where is a dividend paid?

We will be discussing how stocks can be purchased in a follow-up blog post, but for now, it suffices to say: dividends are paid to shareholders through the same account they use to purchase stocks.

You can equate this to how banks pay you interest – it gets deposited into your bank account.

What is an earnings call?

An earnings call is one of the responsibilities of a publicly listed company. It is quite literally a teleconference, or webcast, in which the company discusses the financial results of a specific reporting period.

During this call, the general financial health of a company is scrutinized and analyzed by hundreds of investors across the world.

These calls tend to impact the price of a company’s stock and can partly explain volatility in the stock market. The volatility that comes with them is also totally normal.

Do all companies pay dividend?

Public companies are not required to pay dividends. And in fact, not all companies pay dividends! If you recall, we discussed that companies can reinvest their earnings or share them with shareholders. In cases where a company would benefit more from reinvesting its earnings to fuel future growth, it most definitely will choose to do that.

As of today, companies like Google, Netflix, and Facebook all do not pay dividends yet still attract a lot of investor interest. Why? Because they are treated as high-growth and high-potential companies. Investors expect the growth in their stock prices to more than make up for the lack of dividend payments made by these companies.

In fact, one school of thought states that when tech companies start paying out dividends, it can be interpreted as a sign that they have no other innovative investments they can make with those earnings than share them with shareholders – not a good sign for the future!

Conclusion

Owning stock in a company entitles you to dividend payouts for that company. If the price of a stock you hold increases over time, you can make profit if you sell it. Dividends are a “bonus” payout you get while holding a stock. Dividends are a very good regular stream of income. There are two ways to make money in stocks: dividends plus underlying stock appreciation. Not all companies should be looked at equally: some have high dividend yields, others have high growth potential.