Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.
When a company earns a profit and has earnings it is inclined to do something with that money that will benefit both the company and its investors. Some companies choose to reinvest in themselves in the form of retained earnings to reinvest in the company or pay off debt. Other companies buy back stocks to raise the value of their shares. And some companies choose to distribute their earnings to their investors.
Companies that directly share their earnings, or money made from conducting business, with their investors issue something called dividends. The money from dividends goes to investors without them having to change their positions with their stocks, such as buying or selling, to make that money. They simply have to be shareholders in the company.
Dividends are not often common for start-ups, high-growth companies, or companies in sectors that have very high growth and expansion costs such as biotech. Large, well established corporations with high positive cash flow are incentivized to maximize the wealth of their shareholders and issue dividends to satisfy that need. If a company regularly issues dividends, it is usually a positive sign for the health of the company. And if company suddenly stops offering dividends, it’s typically a sign of trouble, either in the company or the market as a whole.
Dividend payments have to be approved by shareholders, who must also decide on how the payments are made. They can be either a special one-time lump sum or an ongoing recurring payment that is monthly, quarterly, yearly etc. The amount of money is paid on a per share basis, so the dividend can be a small amount but can grow quickly based on a large number of shares.
Owning stocks that pay dividends is a good step toward building your finances.
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