What are dividends and how do they work? (2024)

What are dividends?

Dividends are a portion of a company’s profit that it chooses to return to its shareholders. They are one of the ways a shareholder can earn money from an investment without having to sell shares. Dividends are paid according to how much stock an investor owns and can be paid monthly, quarterly, semi-annually or annually. For example, if the dividend is 50p a year and you own 100 shares, you would receive £50, that year.

Dividends are attractive incentives for shareholders, reassuring them that the company they’ve invested in is profitable and that there is a good possibility of future earnings. They are also given special tax status in many countries.

Not all companies pay dividends, some choose to reinvest profits back into the business. This is why investors who are interested in dividend payments must deliberately choose companies that offer them. If an investor did not want to trade individual stocks, they could decide to invest in a dividend-paying exchange traded fund (ETF), which holds many different stocks. This means they will only have one investment, but with more than one dividend opportunity.

Learn more about how to invest in shares

There are different types of dividends that can be received. In addition to regular dividends, there are also special and preferred dividends – although these aren’t as common.

Special dividends are similar to regular dividends because they are paid on common stock. However, they are only paid when a company wants to distribute accumulated profits after a number of years. Preferred dividends are those issued to shareholders that own ‘preferred’ stock, which is stock that acts more like a bond and has a fixed dividend amount. These dividends take priority over regular dividends.

While most companies pay dividends into a shareholder’s account in cash, some choose to pay dividends in the form of property or shares instead.

Dividends are decided and administered by a company’s board of directors. However, shareholders must approve the dividend payment before it is officially confirmed via an announcement. Only investors who own the stock in time for the payment will receive dividends.

Learn more about share dealing and dividends on IG Academy

Why do companies pay dividends?

Companies pay dividends for many different reasons, including to attract and retain investors. They can help maintain trust and favour – as certain shares could be seen as superior to a competitors’ if they pay dividends.

When a company stops paying dividends, it can be seen as a signal by investors that the business is in trouble. When it cuts the dividend amount, it could mean that the business is seeking other ways to magnify returns for shareholders in the long run. On the other hand, when a company does pay dividends, it may indicate that it does not have other avenues to generate returns, which is why it does not reinvest the capital.

One way to measure the guarantee of receiving a dividend is to check the portion of the company’s profit that goes toward the dividend, or to confirm the pay-out ratio. It may not be sustainable for a company to use a high percentage of its net income for dividend payments. This should be seen as a warning sign; the stock may be in trouble.

Discover the 10 best UK dividend stocks to watch

How do dividends affect share prices?

When dividends are announced by a company, its share price may rise if it is a surprise increase. After a dividend is paid, its share price is likely to fall by the same value as the dividend. It is also possible for competitors’ share prices to be affected by dividend payments, as investors seek larger dividends.

An issuing company’s share price will tend to rise because investors get excited about the prospect of dividends and may want to buy more shares before the pay-out. However, if the share price falls instead, it may be because the company that issues the dividend is expected to use its existing reserves to pay the shareholder.

Indices are also affected by dividend payments. That’s because indices are made up of numerous stocks, so when a constituent’s share price drops after a dividend payment, the price of the index will as well.

What is dividend yield?

Dividend yield is a ratio that measures a company’s annual dividends compared to its share price, expressed as a percentage. For example, if a company with a stock worth £5.00 is paying an annual dividend of 20p, the dividend yield is 4% (20p/£5.00). Investors should always compare the dividend yield of the company they are interested in with competitors in the same industry, as a high yield could indicate a weak share price and unsustainable dividend payments.

A dividend yield will increase if the company raises the dividend amount or if the share price drops. Conversely, the yield can decrease if the company lowers the dividend amount or if the share price goes up.

Dividends and compounding wealth

Dividends can be reinvested to increase the size of a holding, with this known as compounding wealth. The result of reinvesting dividends is that the return on investment over time is not only based on the capital growth relating to the initial amount that the investor deposited, but also on any dividends that are accumulated while the position is open.

For example, if the original investment is £1000 in shares worth £5 (200 shares), and the investor earns a 20p dividend per stock, they will earn £40 dividend on this investment in the first year. If the share price grew by £1 each year, and the dividends remained at 4%, an investor would have made £760 from dividends after ten years and own shares worth £2800 (£14 x 200 shares). The total return on investment would have been £2560 – that’s £1800 in share price growth plus £760 from dividends.

However, if they reinvested the money they earned from dividends, their investment and returns would have increased year-on-year. The increase in the investment with reinvested dividends is over and above the share price growth alone.

In this example, the reinvestment would have earned the investor 91 extra shares on which to receive dividends. The total return on investment would have been £3074, which is £514 more than they would have received had they taken the dividends in cash.

Buy shares from as little as £3 with an IG share dealing account

How do dividends work in the UK?

In the UK, the amount and frequency of dividends paid to investors is determined by the individual company. The dividends are paid from profits, but some companies make dividend payments from their retained earnings even if they don’t make a profit – this is to maintain favour with shareholders. The only requirement before paying dividends in the UK is that the company must first pay all regular taxes and expenses.

There are two payment dates, depending on the dividend. Final dividends are paid annually, at the end of the financial year, while interim dividends are paid throughout the year – monthly, quarterly or semi-annually.

The company does not have to pay tax on the dividend payments it issues, but the shareholder receiving the dividend may have to pay tax on the amount received. An investor in the UK may receive up to £2000 in dividends before they have to pay income tax on the imbursem*nt.1

Important dates for dividends

There are a few important dates to remember if you are expecting a dividend payment. These include:

  1. The dividend announcement date, which is the date at which the company’s management team announces the details of the upcoming dividend payment
  2. The ex-dividend date, also known as the ex-date, which is the date by which an investor must own shares to qualify to receive dividend payments
  3. The record date, which is the cut-off day for the company paying the dividend to decide which shareholders qualify to receive it
  4. The dividend payment date, which is the day on which the dividend payment is made to shareholders

Dividends when investing

Dividends are commonly associated with investing. With dividend investing, the aim is to buy shares in a company that is profitable enough to pay them. The investor buys shares and receives dividend payments based on their shareholding. Dividend investing is an alternative style to growth and value investing, which is the practice of either holding onto fast growing companies or holding onto cheap companies in the hopes of achieving long-term share price growth.

Dividends when trading

Dividends are not paid when trading, but holders still benefit from them. This is because trading is carried out using derivative products, which take their price from the underlying market. Derivative products do not require traders to own the underlying asset to open a position, which means that a trader will not gain any shareholder rights, such as voting abilities or dividends.

Although dividends can affect share prices, they will have no material effect on a trader’s open positions with IG. That’s because positions are adjusted based on the dividend amount and position size. If the trader holds a short position, and the share price goes down after a dividend payment, IG will debit the account to bring the trader’s position in line with the new price. If the trader holds a long position when this happens, IG will credit the account to make sure the trader does not run any losses due to the dividend payment.

The important thing to remember is that whether a trader is long or short on the stock, they will not materially be gaining or losing when dividends are paid to shareholders and a dividend adjustment is made.

Find out more about dividend adjustments

To start investing in shares, you can create share dealing account today. If you want to trade shares instead, you can create a trading account. Alternatively, you can practise and improve your skills using a demo account.

Dividends summed up

  • Dividends are a portion of a company’s profit that it chooses to return to its shareholders
  • There are different reasons why a company may choose to pay dividends including to attract and retain investors
  • When dividends are paid, it’s common for share prices to fall because the company uses its own profits to pay them
  • Shareholders can reinvest the dividends received and benefit from compounding wealth
  • To start investing in shares, open an IG share dealing account today

1Tax laws are subject to change and depend on individual circ*mstances. Tax law may differ in a jurisdiction other than the UK.

I'm a seasoned financial expert with a deep understanding of investment strategies, particularly in the realm of dividends. My extensive experience and knowledge in the field allow me to provide valuable insights into the concepts discussed in the provided article.

The article covers various aspects of dividends, which are crucial for investors seeking to generate income from their investments. Let's delve into the key concepts mentioned:

1. Definition of Dividends:

Dividends are a portion of a company's profit that is distributed to shareholders. They serve as a way for investors to earn money without selling their shares. Dividends can be paid monthly, quarterly, semi-annually, or annually based on the investor's stock ownership.

2. Types of Dividends:

  • Regular Dividends: Paid regularly to common stockholders.
  • Special Dividends: Distributed when a company wants to share accumulated profits after a period.
  • Preferred Dividends: Issued to shareholders owning 'preferred' stock, prioritizing them over regular dividends.

3. Dividend Payment Methods:

Dividends are typically paid in cash, but some companies may choose to distribute them in the form of property or shares.

4. Reasons Why Companies Pay Dividends:

Companies pay dividends to attract and retain investors, maintain trust, and signal profitability. The cessation or reduction of dividends can be interpreted by investors as a sign of trouble or a shift in the company's strategy.

5. Impact on Share Prices:

  • Share prices may rise upon the announcement of dividends.
  • After payment, share prices may fall by the same value as the dividend.
  • Indices can be affected as well, especially when a constituent's share price drops post-dividend.

6. Dividend Yield:

Dividend yield is a ratio measuring a company's annual dividends compared to its share price, expressed as a percentage. It's essential for investors to compare dividend yields among companies in the same industry.

7. Dividends and Compounding Wealth:

Reinvesting dividends can lead to compounding wealth, enhancing the overall return on investment over time.

8. Dividends in the UK:

In the UK, companies determine the amount and frequency of dividends, which can be paid from profits or retained earnings. Tax implications exist for shareholders receiving dividends.

9. Important Dates for Dividends:

  • Dividend Announcement Date
  • Ex-Dividend Date
  • Record Date
  • Dividend Payment Date

10. Dividends in Investing vs. Trading:

Dividend investing involves buying shares for regular dividend income, while trading focuses on derivative products without ownership rights or dividends.

This comprehensive overview should provide a solid understanding of dividends and their implications for investors and traders. Feel free to ask for further clarification on any specific aspect.

What are dividends and how do they work? (2024)


What are dividends and how do they work? ›

A dividend is a portion of a company's earnings that is paid to a shareholder. The most common type of dividend is a cash payout, but some companies will issue stock dividends. Dividends are typically issued quarterly but can also be disbursed monthly or annually.

How do dividends WORK example? ›

What Is an Example of a Dividend? If a company's board of directors decides to issue an annual 5% dividend per share, and the company's shares are worth $100, the dividend is $5. If the dividends are issued every quarter, each distribution is $1.25.

How long do you have to hold a stock to get the dividend? ›

The ex-dividend date is the first day the stock trades without its dividend, thus ex-dividend. If you want to get the dividend payment, you need to own the stock by this day. That means you have to buy before the end of the day before the ex-dividend date to get the next dividend. In other words, it's the cut-off date.

How do dividends make you money? ›

In order to collect dividends on a stock, you simply need to own shares in the company through a brokerage account or a retirement plan such as an IRA. When the dividends are paid, the cash will automatically be deposited into your account.

How do you know if a stock pays dividends? ›

Many stock brokerages offer their customers screening tools that help them find information on dividend-paying stocks. Investors can also find dividend information on the Security and Exchange Commission's website, through specialty providers, and through the stock exchanges themselves.

Do you pay tax on dividends? ›

It is taxed accordingly at your usual rate of income tax, but the 'personal savings allowance' can mean all, or a portion of this, is tax free – there's more information on this from the HMRC website here. For funds with less than 60% in fixed income investments, any income will be classed as dividend.

What stock pays the highest dividend? ›

20 high-dividend stocks
CompanyDividend Yield
Franklin BSP Realty Trust Inc. (FBRT)11.60%
Angel Oak Mortgage REIT Inc (AOMR)11.58%
Altria Group Inc. (MO)9.79%
Washington Trust Bancorp, Inc. (WASH)9.16%
17 more rows
7 days ago

What are the disadvantages of dividend stocks? ›

The Risks to Dividends

Despite their storied histories, they cut their dividends. 9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.

What is a good dividend yield? ›

What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.

Are dividend stocks worth it? ›

Dividend investing can be a great investment strategy. Dividend stocks have historically outperformed the S&P 500 with less volatility. That's because dividend stocks provide two sources of return: regular income from dividend payments and capital appreciation of the stock price. This total return can add up over time.

How much to make $1,000 a month in dividends? ›

In a market that generates a 2% annual yield, you would need to invest $600,000 up front in order to reliably generate $12,000 per year (or $1,000 per month) in dividend payments. How Can You Make $1,000 Per Month In Dividends?

How much to make $1,000 a year in dividends? ›

At recent prices, shares of Altria Group (NYSE: MO), Ares Capital (NASDAQ: ARCC), and AT&T (NYSE: T) offer an average yield of 8.5%. This means you can secure $1,000 of annual-dividend income by investing about $11,765 spread evenly among them.

How much do I need to invest to make 1000 a month? ›

To make $1,000 per month on T-bills, you would need to invest $240,000 at a 5% rate. This is a solid return — and probably one of the safest investments available today. But do you have $240,000 sitting around? That's the hard part.

Is it possible to live off dividends? ›

It is possible to achieve financial freedom by living off dividends forever. That isn't to say it's easy, but it's possible. Those starting from nothing admittedly have a hard road to retirement-enabling passive income.

How much stock do you need to get dividends? ›

If you own 100 shares of a $50 stock that yields 2%, you can expect to receive $100 in annual dividend income. If you have a goal of generating $10,000 in annual dividend income from that $50 stock, you would need to own $500,000 worth, or 10,000 shares, of that $50 stock.

What stock pays dividends monthly? ›

7 Best Monthly Dividend Stocks to Buy Now
StockMarket Capitalization12-month Trailing Dividend Yield
Modiv Industrial Inc. (MDV)$112 million7.7%
LTC Properties Inc. (LTC)$1.3 billion7.2%
Realty Income Corp. (O)$44 billion6.4%
PermRock Royalty Trust (PRT)$53 million10.3%
3 more rows
Feb 29, 2024

How are dividends calculated for dummies? ›

You can calculate the dividend payout ratio using the following formula:
  1. (annual dividend payments / annual net earnings) * 100 = dividend payout ratio.
  2. (3M / 5M) * 100 = 60%
  3. year-end retained earnings – retained earnings at the start of year = net retained earnings.
  4. $10M – $5M = $5M retained earnings.

What is dividend income for dummies? ›

Dividends are payments a company makes to share profits with its stockholders. They're one of the ways investors can earn a regular return from investing in stocks. Dividends can be paid out in cash, or they can come in the form of additional shares.

Can you live on dividends? ›

It is possible to achieve financial freedom by living off dividends forever. That isn't to say it's easy, but it's possible. Those starting from nothing admittedly have a hard road to retirement-enabling passive income.


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