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How do Dividends Work

Dividends are part of the reason why investors prefer the stocks of certain companies. This article aims to explain how dividends work to distribute company profits among its shareholders.
WealthHow Staff
Dividends are given out by companies to their shareholders when they earn profits over a period of time. They are a way of sharing profits with shareholders, who are partial owners of the enterprise.

Stock Dividends

Almost all profitable companies, with a substantial market capitalization and high sales, are known to consistently distribute dividends to their stockholders.

Though it is not binding to share a certain percentage of dividends every year, companies try their level best to keep their shareholders satisfied by issuing them. The dividends can also help companies retain and improve their reputation in the market as an investor-friendly stock.

Generally, it has been observed that firms with fewer profits are not consistent when it comes to dishing out dividends. This is because the inconsistent cash flow, low liquidity, fewer orders, high debt (which causes an outflow of interest to banks and financial institutions), and low profits make it almost impossible for them.

We all know that the stock market is very volatile. Millions of company shares are bought and sold in a single stock trading session. So, whom should a company give the dividend, when shares are exchanged very frequently? To decide this, it is essential for the company to identify the true owners of the stocks. For this, the company declares a record date and at many places, it is required that you own the shares in the company on this particular date. In fact, you will have to complete your trade in this stock around three days prior to this record date.

All those investors who qualify for the dividend finally receive it directly into their registered bank accounts. It is important to understand that dividend is an amount which is paid per share. The amount which is to be paid to all the shareholders per share, or the dividend payout ratio is decided by the board of directors, after taking the financial position of the company into consideration.

The company management would never want to stretch or put a strain on their finances to give out dividends. Dividends are only declared when the firm has cash surplus. This is why, many technical analysts and stock investment counselors advise investing in stocks that pay dividends. However, if you end up buying shares, just for the sake of dividends, in a bad company, you may be at a loss, even if you get the dividend, because the market price of such stocks can decline steeply in market crashes. Now, should dividends be taxed? This has always been an issue of large-scale debate. Many people believe that since the companies pay taxes on their profits, there is no need to tax the dividends. Also, there are some others who are in favor of taxing dividends. In USA, as well as Canada, the dividends are taxed.