What are Dividends?

Dividends are a portion of the company profits paid out to its shareholders. When a company earns a profit, there are two ways in which it can utilize the surplus funds. The company can either decide to reinvest the profits in the business (retained earnings), or distribute it to the shareholders. The distribution of cash to the shareholders can also take two forms: one is share repurchase, and the other is dividends.

In most companies, a part of the profits are kept as retained earnings and the remaining is distributed to the shareholders.

Here are a few salient features of dividends.

  • The dividends are generally paid based on a payout policy of the company.
  • The board of directors of the company declare the dividends every year. In some jurisdictions, such as UK, these board actions require the approval of the shareholders. However, in other jurisdictions such as US, such approval may not be required.
  • Dividends are generally paid as a fixed amount per share. For example, $1 per share. Therefore, the shareholders will receive the dividends based on their holdings.
  • Unlike, the payment of interest and principal of corporate bet, the payment of dividends to common shareholders is not mandatory, as based on the company performance, the company may decide not to pay dividends in a particular year.
  •  Payment of dividend is not considered an expense, rather is paid to shareholders from the after-tax profits. In some jurisdictions, the dividends may be taxed at the shareholder level. The tax treatment of dividends may also differ from capital gains tax.
  • The dividends can be paid in may forms such as cash dividends, extra dividends, stock dividends, stock splits, and reverse stock splits.

The payment of dividends is important for financial analysts as they affect the stock prices and the return on investments.