The entire purpose of becoming a shareholder is to increase your initial investment by being entitled to a portion of the company’s overall earnings. This will be reflected both in the share price and in the form of dividends. Dividends are taxable payments given to shareholders by the companies Executive Board and financed by the company’s current or retained earnings (earnings that are not paid out as dividends but retained to be reinvested in the core business or to pay of debt obligations). Dividends are usually given to shareholders as cash – with their value being determined by the Executive Board – or can be given out in the form of shares. One dividend payment is received for each share held in the company thereby meaning the more shares you hold, the more dividends you are entitled to.
Dividends are not required to be given out by companies, and usually are an added incentive for shareholders to invest. Companies that choose to declare them do so because they have either:
- Over performed and wish to give their profits back to the shareholders instead of reinvesting these earnings back into the company
- No longer benefit from reinvesting their profits, and in order to increase shareholder sentiment they pay these earnings back in the form of dividends.
They are also a very good indicator of future company performance, because usually only more established and profitable companies pay them out. If a company believes that it’s retained earnings would be more beneficial reinvested back into the company so that it can drive its future growth higher – these are typically new and establishing companies – it will not choose to pay dividends and shareholders will hopefully see an increase in their investments by a rise in the share price. Equally, even well established companies that decide to pay out dividends still need to retain enough of their earnings to ensure that future business needs can be controlled.