A dividend is the part of its profit that a company hands to its shareholders in cash. For many investors it is the most tangible part of owning a stock: money that arrives in the account without selling anything. But a dividend has its own calendar, its own traps and its own way of being judged. This guide covers all three.
What a dividend is
When a company makes a profit it can do several things with it: reinvest it in the business, pay down debt, buy back its own shares or distribute part of it to shareholders. That distribution is the dividend.
It is usually expressed per share: a company that announces a dividend of 0.50 per share pays 0.50 for every share you own. Some companies pay once a year, many European companies pay twice, and most large US companies pay every quarter.
A dividend is a decision of the board, not an obligation. A company can raise it, keep it, cut it or suspend it. That is why judging whether a dividend is sustainable matters as much as its size.
The four dates of a dividend
Every dividend has a small calendar, and only one of the dates really matters to someone thinking of buying:
- Announcement date. The company announces the amount and the other dates.
- Ex-dividend date. From this day, the share trades without the right to the announced dividend.
- Record date. The day the company checks who its shareholders are.
- Payment date. The day the money reaches the accounts.
The ex-dividend date is the one that counts
To receive the dividend you have to own the share before the ex-dividend date. In practice, buying at the latest in the session before it. If you buy on the ex-dividend date or later, the dividend goes to the seller.
If you sell on the ex-dividend date or later, you still receive the dividend, even though you no longer own the share when it is paid.
Why the price falls on the ex-dividend date
On the ex-dividend date the share usually opens lower by roughly the amount of the dividend. It is logical: that cash is leaving the company, so each share is worth a little less.
Hypothetical example: a share closes at 40.00 the day before the ex-dividend date and the dividend is 1.00. All else being equal, it should open around 39.00. Whoever held it has a share worth 39 and 1.00 to be received: the same 40 as before, now split into two parts.
That is why "buying just before the dividend and selling just after" is not free money. The price adjusts, and on top of that the dividend is usually taxed, often with a withholding at source and, for foreign shares, sometimes twice. Once tax and commissions are counted, the operation usually loses.
Dividend yield: how much it pays relative to its price
The dividend yield relates the dividends of a year to the share price:
Dividend yield = annual dividend per share / share price
Hypothetical example: a share at 50 that pays 2 a year has a 4% dividend yield.
It is useful for comparing companies, but it has an important trap: the yield rises when the price falls. A company whose share has collapsed can show a spectacular yield simply because the market expects the dividend to be cut. A very high yield, far above that of similar companies, is a question, not an opportunity.
It is also worth remembering that the yield is usually calculated with the dividends already paid. If the next one is cut, the real yield will be lower than the one on the screen.
The payout ratio: what part of the profit is distributed
The payout ratio measures how much of the profit goes to dividends:
Payout = dividends / net profit
- A payout of 40% means the company distributes less than half of what it earns and keeps the rest.
- A payout of 100% means it distributes everything it earns, with no margin for a bad year.
- A payout above 100% means it is paying more than it earns: it is drawing on reserves or on debt.
There is no universal correct level. Regulated utilities or property companies often distribute a large part of their profit by design, while a growing company keeps most of it. What matters is whether the payout leaves room for a bad year.
Free cash flow coverage: is the dividend paid with real cash?
Profit is an accounting figure. Dividends are paid with cash. That is why many analysts prefer to compare the dividend with the free cash flow, the cash left after running the business and making the necessary investments:
Coverage = free cash flow / dividends paid
A coverage of 2 means the company generates twice the cash it needs for the dividend. Below 1, the dividend is not covered by the cash of that year and is being financed some other way. One year below 1 can be an accident; several in a row are a warning.
We explain free cash flow in more detail in P/E, Free Cash Flow and Book Value.
How to tell a sustainable dividend
No single figure decides it, but together these questions say a lot:
- Is the payout reasonable for its sector? Close to or above 100% leaves no room.
- Does the free cash flow cover it? Year after year, not just in one good year.
- How long has it been paid without interruption? A long record across several crises says something about the board's commitment.
- How much debt does the company carry? A company with heavy debt may have to choose between its creditors and its shareholders.
- Is the yield in line with similar companies? A yield far above the rest usually anticipates a cut.
The quality of the business matters too: a dividend is only as solid as the profits behind it. We cover that side in Company Quality: ROE, Debt and Margins.
Dividends at InbestPlanners
The dividend ranking orders the companies we cover by a dividend score that looks at four things: the dividend yield, the payout ratio, the number of consecutive years of payments and the free cash flow coverage. A high yield is not enough on its own to rank well if it is not backed by the other three.
The 360 Analysis of each company shows those same measures next to its quality, value and technical picture, and its corporate calendar includes the next ex-dividend date, the payment date and the last dividend paid, so you know when the share will start trading without it.
The dividend score describes the dividend; it is not a signal. Neither of our signal methods uses it to decide an entry. The full description is on the methodology page.
In short
- A dividend is profit distributed in cash; the board can raise it, cut it or suspend it.
- To receive it you must own the share before the ex-dividend date.
- On the ex-dividend date the price usually falls by about the dividend: buying just for the dividend is not free money.
- The yield rises when the price falls; a very high yield is a question, not an opportunity.
- Judge sustainability with the payout, the free cash flow coverage, the payment record and the debt.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results.