What are dividends?
Dividends are distributions of a company’s earnings to its shareholders, typically paid out quarterly and on a per-share basis. Because holding stock in a company makes you a partial owner, you can simply think of dividends as your share of company profits. Dividends are also the only way investors can profit from stock ownership without selling shares and, therefore, eliminating all or a portion of their stake in the company.
While a majority of dividend stocks pay “cash dividends,” corporations may also distribute “stock dividends,” meaning they compensate stockholders with additional shares rather than paying them a share of earnings. This typically occurs when a company wants to increase the number of shares outstanding or reward investors while maintaining liquidity.
Why do companies pay dividends?
When a company earns a profit and has excess cash they have three options: they can reinvest in their operations, pay down debt obligations, or distribute the cash to shareholders as dividends. Not all corporations distribute dividends to investors. Many new or rapidly expanding companies opt to reinvest earnings in further organizational growth. But for mature, stable corporations with consistent cash flows, dividends can be a great way to reward and retain shareholders.
Investors often view dividend payments as an indication of company strength and a positive outlook for future earnings, and dividend stocks are often attractive to investors looking to generate income on their holdings. Therefore, issuing dividends often increases demand for a stock and, in turn, bolsters the stock price.
What are dividend dates?
Investors holding dividend stocks should be aware of four important dates:
- Declaration date: The date a company’s Board of Directors announces an upcoming dividend payment.
- Ex-Dividend date: The day on which shares bought and sold no longer carry the right to the previously announced and yet-to-be-paid dividend. If you own a stock before market open of the ex-dividend date, you are entitled to the dividend. If you purchase a stock on or after this day, you are not owed the dividend.
- Record date: The day after the ex-dividend date, and the date the company uses to determine its shareholders or “holders of record.”
- Payment date: The day a dividend will be paid to a stock or fund owner.
It’s important to remember your earned dividends and your received dividends will differ between the ex-dividend date and the payment date. Once all earned dividends have been paid, however, these numbers will be equal. Consider the following example:
Stock ABC has an ex-dividend date of 1/15 and a payment date of 1/25.
Stacy bought a share of ABC on 1/14 and Eddie bought a share of ABC on 1/15. Stacy is owed the dividend and Eddie is not. Stacy will be paid the dividend on 1/25. Between 1/15 and 1/25, Stacy will have earned the dividend but not yet received it, and her earned dividends will exceed her paid dividends. On 1/25, the cash dividend will flow into Stacy’s account, and her paid dividend will match her earned dividend.
Want to track your dividends in the M1 app? Navigate to your portfolio and click the gain dropdown to view earned dividends. Paid dividends can be found under the “Activity” tab.
What are the benefits of dividend stocks?
Dividend stocks often provide a steadier source of income than growth stocks, allowing investors to build wealth without selling their shares.
But the true wealth-building power of dividend stocks comes with reinvesting. Funneling your dividends back into your portfolio allows you to benefit from compound interest, so you continue to profit from dividends long after they are initially paid. This can lead to millions in additional investment returns over 30 to 40 years.
How are dividends treated in your M1 portfolio?
M1 even further maximizes the wealth-building potential of your dividends by allowing you to reinvest automatically, so cash always goes to work rather than sitting idly in your account. When any security pays you a dividend, the cash will be deposited directly into your M1 account. If a dividend payment causes your cash balance to exceed $10, the entire cash balance will be automatically reinvested across your entire portfolio based on your portfolio targets. Try it now: