dividend – a portion of the (after-tax) profits that is paid to shareholders (the owners) according to the number of shares they own
The simplest way to remember the term dividend is to split the word up as follows:
Think of dividing a portion of the profits at the end (dividend) of the financial year and distributing it among shareholders.
DIVIDe at the END = Dividend
A dividend is a distribution of the (post-tax) profits, payable to all shareholders in proportion to their shareholdings.
To decide how much of the profits to give to the shareholders, the board of directors will first look at its last annual accounts (which is circulated to all shareholders).
If you are the only shareholder and you own one share, that share entitles you to 100% of available profits in the form of a dividend payment. If the company has four shareholders and each person owns one share, these shares entitle each shareholder to 25% of available profits in the form of dividend payments. That money will be sent to the shareholder’s bank account but they will have to pay personal tax on the dividend money just like any other income. However, this will be a lower rate of tax because the company has already been charged corporation tax. Note, partnerships (i.e. not a limited company) cannot issue dividends, governments don’t allow it.
Some companies pay out all their earnings to shareholders, but most pay out a smaller portion of their earnings. If a company pays out some of its earnings as dividends, the remaining portion is retained by the company for reinvestment in future projects.
The average yearly dividend yield payment on profits of the top 100 largest companies on the London Stock Exchange from the year 2000 to 2020 has been 3.76%. Dividend yield means if you bought £100 of shares in these companies on average you would have received £3.76 each year. Note, this doesn’t include the fact that the value of the shares may have gone up in value too. When you come to sell the shares, they would have made an additional profit.
Dividends can be paid monthly, quarterly, or yearly. The amount of the dividend is determined by the company’s board of directors and it is based on the company’s profits and cash flow.
Shareholders are entitled to dividends if they own shares in a company on the record date. The record date is the date that the company uses to determine who is entitled to receive the dividend. Shareholders who own shares on the record date will receive the dividend, even if they sell their shares before the dividend.
Dividends can be paid in cash or in more shares of stock and are a way that companies can attract and retain investors. Investors are more likely to invest in a company that pays dividends, because they will receive more rewards for their investment.
A company isn’t obliged to pay dividends to shareholders even if they have made a large profit and have ample cash reserves. There are a number of factors that companies consider when deciding whether or not to pay dividends. These factors include the company’s profits, cash flow and future plans. If a company is planning to make a major investment in the near future, such as building a new factory, then profits would likely be retained to help fund this instead of being distributed as dividends.