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What is a dividend?
A dividend is a portion of a company’s profits paid out to the company’s shareholders. When a company makes a profit, it can choose to reinvest that profit back into the business, but sometimes it pays a percentage of it back out to shareholders. Not every company pays dividends, but those that do often have slow, reliable growth.
Most dividends are paid out as cash to shareholders. When they’re on a fixed schedule, such as quarterly or annually, they’re called regular dividends, but a company may pay out a dividend at any time, which is called a special dividend.
Not all companies pay dividends. Newer industries, like tech startups, often choose only to reinvest their profits into the company. They are usually growing faster than more established companies, and their stock price might fluctuate with greater volatility. There’s little incentive to pay out dividends when the stocks themselves may offer more value and when it’s more strategic to invest as much of the profits back into the business as possible.
By contrast, more established companies rarely see the price of their stocks vary by too much. In order to incentivize shareholders, they may pay dividends, because the shareholders won’t expect the amount the value of the stock to exceed what they paid for it by that much.
The value of a dividend is usually announced by the company as a dollar amount or as percentage of the price of each share, which is called a dividend yield. Let’s say a company announces a special dividend payment of 1.5% per share. If the stock is worth $100 per share, and you own 100 shares, you stand to earn $150. Sometimes a company may pay the dividend in more shares of the stock, which could potentially be more valuable.
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Blue Buffalo is a well-established energy drink maker. Each year, they post fairly predictable profits and haven’t really managed to produce much growth for their shareholders. They decide to implement a regular quarterly dividend system to keep their shareholders happy. For the first quarter, Blue Buffalo pays dividends out at 1% per share, but shareholders want more. They switch to a yearly 7% per share dividend, and at a stock price of $40 each shareholder receives $2.8 per share.