What are Dividends?

40% of total stock returns come from div­i­dends, but what are div­i­dends?

From Part 2 of my book:

When you pur­chase shares in a com­pa­ny, you become a par­tial own­er of that com­pa­ny. When buy­ing shares on a stock mar­ket through a bro­ker­age, you’re buy­ing shares of a pub­lic com­pa­ny – a com­pa­ny that has offered shares to the pub­lic mar­ket as a way to raise mon­ey. You prob­a­bly do busi­ness with lots of pub­lic com­pa­nies like AT&T, Starbucks, and Ford.

Buying shares in a pub­lic com­pa­ny is just like invest­ing in a local restau­rant or buy­ing shares in a start­up – at least con­cep­tu­al­ly. You give the busi­ness mon­ey in exchange for a per­cent­age of own­er­ship.

Many pub­lic com­pa­nies take all the prof­it and put it back into the busi­ness. Some return some of that prof­it to the own­ers (share­hold­ers).

Dividends are the return of that prof­it.

Of course, there are details I’m skip­ping over.

Writing about finance in a human voice can be frus­trat­ing at times – and this one of them. Many com­pa­nies who pay div­i­dends don’t actu­al­ly have prof­its, or pay out more than they have in prof­its. This is not always a prob­lem, as the way account­ing prin­ci­ples allow com­pa­nies to define prof­its don’t always reflect cash flow.

For sim­plic­i­ty, I stat­ed that div­i­dends are a return of the prof­it, which is accu­rate enough for the sake of help­ing answer the ques­tion: What are div­i­dends?

Dividends are pay­ments you get from com­pa­nies you own. For con­ser­v­a­tive, estab­lished com­pa­nies (the ones we like for safe­ty), these div­i­dends come quar­ter­ly (every three months).

Dividends are the gift that keeps on giv­ing, you get them every quar­ter. Pick the right com­pa­nies, and they go up faster than infla­tion too, so you are increas­ing your pur­chas­ing pow­er over time.

Don’t need the cash now? Reinvest those div­i­dends and earn even more in the future.