Dividend Stocks Explained for Beginners - What are Dividend Stocks?


Dividend stocks are a familiar term to those with experience in the stock market, yet they can confuse beginners. When someone buys a share of a company, they become an owner of that company. Companies that are profitable and don’t require excess funds for their operations often share their profits with shareholders in the form of cash payments called dividends. This payment is a reward for holding shares in the company.

Not every company pays dividends, and those that do may pay different amounts at various frequencies. They announce these dividends on specific dates, and if an investor owns shares before a certain "ex-dividend date," they will receive a payment on a later "payment date." Dividend payments are taxable, and the tax rate can vary based on whether the dividends are ordinary or qualified. Additionally, the yield, or the percentage return a dividend provides, is an important factor when considering dividend stocks, but extremely high yields can sometimes signal potential problems with the company.

Key Takeaways

  • Dividend stocks reward shareholders with cash payments.
  • Dividend payments are taxable and have specific key dates.
  • High dividend yields may indicate potential issues in the company.

Grasping the Concept of Dividend Stocks

Dividend stocks are shares of a company that regularly pay out a portion of the company's earnings to shareholders. When someone buys a stock, like one share of Microsoft, they essentially become a part-owner of that company. This ownership entitles them to a portion of the company’s profits in the form of dividends, provided the company decides to distribute the excess earnings to shareholders.

How Dividends Work

  1. Ownership and Dividends:
    1. Buying stock means owning a piece of the company.
    2. Companies, such as Microsoft, distribute profits as dividends if they have surplus funds not needed for operations.
  2. Payment Calculation:
    1. The total dividend is divided by the number of shares. For example, if a company with 1 million shares decides to distribute $1 million, each share gets $1.
    2. If you own multiple shares, you receive dividends multiplied by the number of shares you hold.
  3. Dividend Dates:
    1. Declaration Date: The company announces it will pay a dividend.
    2. Ex-Dividend Date: You must own the stock before this date to receive the dividend.
    3. Payment Date: The day when the dividend is actually paid out to shareholders.

Taxes on Dividends

Dividends are considered taxable income, regardless of whether they are reinvested or kept in the brokerage account. The tax rate on dividends varies:

  • Ordinary Dividends: Taxed at regular income rates.
  • Qualified Dividends: Receive preferential tax treatment, depending on the holding period and the company’s qualifications.

Dividend Yield

The yield is an essential metric indicating how much a company pays out in dividends each year relative to its stock price. A yield of 4% means $4 in dividends for every $100 worth of stock owned. High yields, especially those above 7-10%, often signal potential instability or unsustainable dividend levels.

Dividend Payment Frequency

Most companies typically pay dividends quarterly, every three months. This regularity allows for predictable income for shareholders. Some stocks, such as Real Estate Investment Trusts (REITs), may have different schedules.

By understanding dividend stocks, investors can make informed decisions that align with their financial goals and portfolio strategies.

Key Dividend Dates

  1. Declaration Date: The day the company announces it will pay a dividend.
  2. Ex-Dividend Date: The cutoff date to be eligible to receive the dividend. Shares must be purchased before this date.
  3. Payment Date: The day the dividend is transferred to the shareholders' investment accounts.

Dividend Calculations

Dividend calculations come down to simple math. When a company decides to distribute profits to its shareholders, it declares the total amount it wants to give away. For example, if a company has 1 million shares of stock and decides to distribute $1 million, shareholders will receive $1 per share.

The payment amount depends on the number of shares you own. If you own one share, you'll get $1. If you own five shares, you'll receive $5. This money gets credited to your investment account on the payment date specified by the company.

Dividend income is taxable. You'll pay taxes on it, whether you withdraw it or reinvest it. Qualified dividends are taxed at a lower rate compared to ordinary dividends, but this depends on the stock's holding period and the company's status.

Dividend Announcement Date

The declaration date is when a company lets everyone know that a dividend will be paid. This is the official announcement of the dividend being offered. Companies make this announcement well in advance so investors can plan accordingly.

When a company makes this declaration, it specifies important details such as:

  • Dividend amount: how much money each share will receive
  • Ex-dividend date: the cutoff date to qualify for the dividend
  • Payment date: when the dividend will be paid out

For example, if a company with a million shares declares a million-dollar dividend, each shareholder gets $1 per share. The amount each shareholder receives directly correlates to the number of shares they own.

Ex-Dividend Date

The ex-dividend date is one of the crucial dates for dividend investors. It's the date by which you must own a stock to qualify for the next dividend payment. If you buy the stock on or after this date, you won't receive the dividend. Here's a breakdown:

Ex-Dividend Date Key Points:

  • Timing: To be entitled to receive the dividend, one must purchase the stock before the ex-dividend date.
  • Ownership: If the stock is bought on or after the ex-dividend date, the investor will not receive the upcoming dividend.
  • Record Date: The ex-dividend date is set one business day before the record date, the deadline by which investors must be on the company’s books to receive the dividend.

Important Notes:

  • The ex-dividend date can impact stock prices. Stocks often drop in price by the amount of the dividend on the ex-dividend date because new buyers aren’t entitled to the dividend.
  • Taxation: Dividends are taxable. Ordinary dividends are taxed at the regular income rate, while qualified dividends usually get a lower tax rate if certain conditions are met, including holding the stock for a required period.

Understanding the ex-dividend date is essential for making informed investment decisions and effectively managing your dividend income expectations.

Payment Date

The payment date is the day when shareholders actually receive their dividends. On this date, the dividend amount is credited to their investment account as cash. Here's how it works:

  • The company first declares the dividend, announcing that it will pay out a certain amount to its shareholders.
  • Shareholders must own the stock before the ex-dividend date to qualify for the dividend.
  • Finally, on the payment date, the dividend is deposited into their accounts.

Ordinary versus Qualified Dividends

Ordinary Dividends

Ordinary dividends are taxable income. They are taxed just like your regular income, based on your ordinary income tax rate.

Qualified Dividends

Qualified dividends benefit from a lower tax rate. For dividends to be qualified, certain conditions must be met:

  • The company issuing the dividend must be based in the U.S. or a qualifying foreign country.
  • The investor must hold the stock for more than 60 days within the 121-day period that starts 60 days before the ex-dividend date.


Dividend Type Tax Rate Requirements Ordinary Dividends Ordinary income rate No special requirements Qualified Dividends Lower tax rate U.S. or qualifying foreign stock, 60-day holding period prior to the ex-dividend date

Key Points

  • Ordinary dividends are taxed at standard income rates.
  • Qualified dividends are taxed at lower rates, given certain conditions are met.
  • Holding the stock for over 60 days around the ex-dividend date can result in dividends being qualified.

High Dividend Yield Risks

Dividend stocks can provide a steady income, but high dividend yields come with potential risks. A dividend yield reflects the annual dividend payment relative to the stock price. Although high yields can be tempting, they might signal underlying problems within the company.

Unsustainable Dividends: When a stock offers a dividend yield of 7% or higher, it often indicates that the payout might not be sustainable. Companies can face financial strain trying to maintain such high payouts, which may lead to dividend cuts or total elimination.

Business Health Concerns: High dividend yields can be a red flag. They might suggest that the company is experiencing difficulties or declining business prospects. Investors should be cautious and thoroughly research the company’s financial health before investing.

Volatility: Stocks with very high dividends are often more volatile. Market perception can rapidly change, causing significant fluctuations in stock price. This can impact the overall return on investment, especially if the company reduces or stops its dividend payments.

Key Points to Consider

  • Check Financial Statements: Look at the company's earnings and payout ratios to ensure dividends are supported by sustainable profits.
  • Industry Trends: Understand the industry in which the company operates, as sector-specific issues can affect dividend reliability.
  • Management Track Record: Evaluate the company’s history of dividend payments and management’s commitment to maintaining them.

Investing in high dividend-yield stocks requires careful analysis. Always consider the potential risks along with the rewards.

Dividend Payment Frequencies

Dividend payment frequencies can vary depending on the company. Most companies choose to pay dividends every quarter, meaning dividends are distributed every three months. This is a common practice and offers predictability for investors who rely on these payments.

Quarterly Payments

Many companies, including large and stable firms, distribute their dividends four times a year. For instance, if a company announces a dividend of $0.50 per share, shareholders can expect to receive this amount each quarter.

Monthly Payments

Some companies, particularly real estate investment trusts (REITs), opt to pay dividends on a monthly schedule. This provides a more regular income stream for investors who need consistent cash flow. For example, if a REIT announces a monthly dividend of $0.10 per share, shareholders will receive this amount every month.

Semi-Annual and Annual Payments

There are also companies that distribute dividends semi-annually (twice a year) or annually (once a year). These schedules might be less predictable but can result in larger individual payments. For instance, a company might announce an annual dividend of $2.00 per share, providing a substantial payout once per year.

Special Dividends

In addition to regular dividends, some companies may issue special dividends. These are typically one-time payments given when a company has excess profits and decides to reward its shareholders. Special dividends are not on a regular schedule and can vary significantly in amount.


When buying a stock, one is essentially purchasing a piece of the company. For instance, owning even a single share of Microsoft makes the person an owner of Microsoft. Companies sometimes reward shareholders with dividends, especially when they have excess profits not needed for operations. These dividends are cash payments sent to the shareholder’s investment account just for holding the stock.

Different companies have various amounts of stock. For example, a company might have a million shares. If this company wants to distribute a million dollars in dividends, each share would receive one dollar. So, if someone owned five shares, they would receive five dollars in dividends.

Not all companies pay dividends. When a company does, it becomes known as a dividend stock. There are three key dates in the dividend process: the declaration date (when the company announces the dividend), the ex-dividend date (the cutoff date to own the stock and qualify for the dividend), and the payment date (when the dividend is actually received).

Dividends are taxable income, whether reinvested or left in the brokerage account. Taxes on dividends vary based on whether they are ordinary or qualified. The yield of a stock, usually represented as a percentage, indicates how much dividend income is expected. For example, a yield of 4% means if $100 is invested, $4 will be earned in dividends annually.

High dividend yields, such as 7-10% or more, often signal potential problems with the company, and such yields are typically unsustainable. Finally, most companies pay dividends quarterly, making the payments regular and predictable.