Quite simply, a dividend is a payment made to shareholders that represents part of the profit that a company makes. Since the shareholders own the company, they own the profits too. The company’s directors and managers determine how much of the annual profit they would like to pass on to the shareholders and how much of the profit they want to retain in the company for future use. So for example if a company earns a $100 million profit, they might decide that they want to keep $70 million for future use and give $30 million to the shareholders. In that case the dividends are paid to the shareholders proportionate to the amount of stock they each own. If one person owns half the stock, they would get half of the $30 million dividend.
But of course there’s more to it than just that. :) You might ask why they don’t give ALL the profits back to the shareholders though dividends… There are numerous reasons – but the main reason is that the directors and managers believe that the best course of action (i.e. what is most profitable to the shareholders over the long term) may be to keep the cash for re-investment in the company, to save up for an acquisition of a competitor, or if they are in a cyclical business: perhaps they will keep it to offset the years in which they have losses.
Usually you will find that dividends are only paid by large companies with a track record of turning a profit year over year. A newer company (which may still be in it’s growth phase) may not be turning a profit yet, and if they do they may be re-investing in the company on a much more aggressive basis to allow for quick growth into a large company.
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