Understanding the Basics: What is a Dividend

What is a Dividend?

A dividend, in simple terms, is a reward that shareholders receive for owning a company's stock. Companies have dividends to encourage people to buy their stock and to reward people who already hold it.

Think about it like owning a lemonade stand and paying some of the profits to the person who bought the ingredients. The companies that usually pay dividends are big and reliable businesses that don't need to reinvest all of their money, so they reward their shareholders! Companies such as Johnson & Johnson (a healthcare giant) and Coca-Cola (a huge beverage company) all pay dividends.

How Do People Make Money from Dividends?

I'm sure after reading some of our articles that you know the main way to make money in the stock market is through increasing prices. But dividends are a whole other way of making money. Dividends pay through something called a dividend yield. A dividend yield is a percentage of how much a company will pay you for owning a stock. Let’s take Coca-Cola, for example. Their annual dividend yield is 2.87%. This means that if you invest $1,000 into Coca-Cola, no matter if the stock goes up, down, or sideways, you will still make $28.70.

Why Do Only Some Companies Pay Dividends?

Big companies, like the ones we've already talked about, are usually the ones that pay dividends because they have a stable cash flow with steady profits. Their industries are slow-growing, with not much volatility or risk involved, so they can use that extra money to their advantage by giving back to their shareholders.

On the other hand, fast-growing companies like Tesla may not pay dividends because they need to reinvest that money back into their company. Another example that might surprise you is Amazon. Although Amazon is a huge business, they focus on growing their e-commerce platform to the greatest extent and have now even shifted their focus to AI.

Some companies can even stop paying dividends if they want. Take Disney, for

example. In 2020, Disney paused its dividends because the market was performing terribly due to the COVID pandemic. A lot of times when a company does this, it actually makes the stock fall because investors lose confidence in the company.

A good portfolio usually consists of both stocks with dividends and stocks without dividends, balancing steady income with potential growth.