A Dividend Is a Company’s Way of Paying You to Own Its Stock: Here’s How It Works.

What is a dividend? It’s one of the best reasons to own stocks. It lets you get paid without working. It lets you share in the wealth created by the efforts of the world’s best companies.

Dividends are income paid to shareholders, a way of being paid for owning a company’s stock. When you own a company’s stock and that company makes money, it shares part of that money with you.

When a company has a profitable quarter of doing business, it will announce a dividend to be paid to shareholders. Dividends might often sound small, like less than $1 per share per quarter. But they add up over time.

Let’s look at what a dividend is and what dividend payments mean for investors — and how to choose the best high-yield dividend stocks.

What is a dividend? Income you get paid for owning company stock.

Dividends aren’t the only reason to buy stocks, and not every stock pays a high dividend. But if you are a long-term investor, paying attention to dividends can be a smart move. Simply put: Dividends are payments to investors. They make up part of a stock’s total return. Dividends are usually paid in cash, but in some rare situations can be paid with additional shares of stock.

High dividends can be a sign of a company’s financial strength. When a company is making good money and has steady cash flow and a strong balance sheet, it will often give some of that money back to its shareholders in the form of a dividend payment. Dividends are an important way of earning returns for investors. Some of the strongest companies keep paying higher and higher dividends over time.

Which companies pay dividends?

Not every company pays dividends. Companies that are still in early-stage growth mode might not have substantial cash on hand — younger companies often prefer to invest their profits in new products, expansion, and growth instead of paying higher dividends to shareholders. Some companies that are struggling to stay profitable can’t afford to pay a dividend in the first place. If a company is experiencing lower profits or declining revenue, leadership might decide to cut its dividend.

One way of understanding the size of a dividend is to look at a company’s dividend yield. This is the dividend amount divided by the stock’s price. For example, if a stock is priced at $50 per share and the company has paid a dividend of $2 per year, that company’s dividend yield will be 2 divided by 50, or 4%.

You don’t have to own individual stocks to get paid dividends. For example, the S&P 500 index (^GSPC -0.25%) is paying a dividend yield of about 1%, which is near its historic lows. The tech-heavy Nasdaq-100 index tends to pay even lower dividends. The Invesco QQQ Trust (QQQ +0.25%), which tracks the Nasdaq-100, has paid a trailing 12-month dividend yield of 0.42%.

Just by owning low-cost index funds, you can earn income from dividends. But not all stocks or ETFs pay the same dividends. Some are better than others.

How to choose the best dividend stocks

Stocks that pay higher dividends tend to represent companies in more mature industries, not always the fastest-growing tech stocks, for example. Some of the best high-yield dividend stocks are from companies in industries like healthcare, financial services, utilities, and energy.

One easy way to choose high-yield dividend stocks is to buy Dividend Kings. These are companies with a long-term track record of increasing their dividends for at least 50 years in a row. Paying such strong dividends for so many years is a sign of these companies’ financial strength.

Another way to buy dividend stocks is to invest in a high-yield dividend index fund. One of the best of these is the Schwab US Dividend Equity ETF (SCHD -0.97%). This Schwab dividend fund is paying a 30-day SEC yield of 3.34% — much better than the S&P 500. And SCHD has delivered average annual returns of about 10% for the past five years.

Schwab U.S. Dividend Equity ETF

Today’s Change

(-0.97%) $-0.32

Current Price

$32.53

Key Data Points

AUM

$109B

Dividend Yield

3.24%

Expense Ratio

0.06%

Top Holdings

TXN

4.67%

QCOM

4.58%

PG

4.24%

Why not buy dividend stocks?

Dividend stocks aren’t always the best investments. For example, SCHD has underperformed the S&P 500 index for the past five years. Sometimes a company will pay a strong dividend but have a slow-growing share price, making its total return lower than other fast-growing stocks. But if you want to earn reliable income from your stocks, choosing the best dividend stocks can be a good strategy.