Dividends: what they are and how shareholders receive a share of the company’s profits

Buying stocks doesn’t automatically mean you’ll make money. Stock prices can go up or down, and a company isn’t required to regularly share its profits with its shareholders.

One possible way to earn income from investing in stocks is through dividends. These are a portion of a company’s profits that it has decided to distribute to its shareholders.

But where does the right to dividends come from in the first place, and why does one company pay them while another does not? Let’s start with stocks.

What is a share, and what does an investor buy?

A share is a security that certifies its holder’s property rights in a joint-stock company.

When an investor buys shares, they become a shareholder of the company and acquire the rights provided for by law and the type of shares. One of these rights is the right to receive dividends if the company decided to pay them.

Let’s imagine a fictional company called “Coffee & Co.” It issued 1 million shares.

The investor purchased 1,000 shares. This means he owns 0.1% of the company’s stock.

In one year, “Coffee & Co.” earned UAH 10 million in net profit.

Does this mean that these UAH 10 million are going to be automatically distributed among the shareholders? No.

And this brings us to an important question: what can a company do with the money it earns?

A profit is made. But why might there be no dividends?

Once a company has made a profit, it must decide how to use it. And paying dividends is just one of the possible options.

A company may reinvest some or all of its profits back into the business: to purchase new equipment, open a production facility or new retail outlets, finance new projects, pay off debts, or build up a financial reserve.

For example, “Coffee & Co.” earned UAH 10 million in net profit and plans to open another five coffee shops. This requires additional funds. The company may decide not to pay dividends but to direct the profits into expansion.

In other words, a profitable company may very well choose not to pay dividends. And that in itself does not mean there is anything wrong with the business.

There could be another approach to this: the money that isn’t distributed to shareholders today is invested in the company’s growth. If these investments are successful, the business can grow, and with it, the value of its shares may potentially increase as well.

And a different scenario is also possible.

“Coffee & Co.” has decided to allocate its UAH 10 million in net profit as follows:
• UAH 6 million will be set aside for development;
• UAH 4 million will be channeled into dividends.

If a company has 1 million shares, the notional dividend will be 4 UAH per share.

Our investor owns 1,000 shares. Therefore:
1,000 shares × 4 UAH = 4,000 UAH in dividends before taxes.

That is precisely why it is important to distinguish between two concepts: company profit and shareholder dividends. The former does not automatically imply the latter.

What needs to happen for a shareholder to receive dividends?

To put it very simply, the process looks like this:
1. The company achieves a financial result.
Based on the results for the relevant period, it becomes clear what financial result the company achieved.
2. A decision is made regarding profits.
The company decides whether to retain the profits in the business or to use a portion of them to pay dividends.
3. A decision is made to pay dividends.
The dividend amount and the timing of their payment are determined in accordance with the law and corporate procedures, among other things.
4. The shareholders entitled to receive dividends are identified.
For this, a corresponding list of individuals is compiled.
5. Payment is made.
Funds are being transferred to shareholders in accordance with established procedures.
In other words, there are several distinct stages between the phrases “the company made a profit” and “the investor received money.”

In addition, law provides for cases in which a company is not permitted to decide to pay dividends or to make such a payment. In other words, sometimes the absence of dividends is not a business decision by the company, but rather a consequence of restrictions established by law.

Who is eligible to receive dividends?

Another important point: it’s not enough to simply buy shares in a company at some point.

The right to receive declared dividends belongs to persons included in the list of those entitled to receive them, which is compiled in accordance with the law.

Let’s go back to “Coffee & Co.”

The company announced a dividend of 4 UAH per share. Our investor owns 1,000 shares and is included on the relevant list.

Therefore, he is entitled to UAH 4,000 in dividends before taxes.

Payments to shareholders of the same type and class of stock are made in proportion to the number of shares they hold.

Therefore, under the same conditions, an investor with 100 shares will receive UAH 400, one with 1,000 shares will receive UAH 4,000, and one with 10,000 shares will receive UAH 40,000 before taxes.

How the money reaches the investor

In Ukraine, dividends may be paid through the depository system or, in cases provided for by law, directly to shareholders.

For the investor, this means that a significant part of the process takes place through the capital market infrastructure, where the rights to their securities are recorded.

If dividends are paid through the depository system, this process can be simplified as follows:

a joint-stock company → the Central Securities Depository → a depository institution → a shareholder.

In other words, stockholders do not need to visit the company after every dividend announcement to prove how many shares they own. Information regarding share ownership is recorded in the depository system, and the list of individuals entitled to receive dividends is compiled in accordance with the established procedure.

Why high dividends aren’t always good news

At first glance, it seems simple: the higher the dividends, the better the investment. But in practice, that’s not always the case.

Large payments may be one-time payments — for example, following the sale of part of the enterprise or using accumulated profits from previous years.

In contrast, a company that does not pay dividends today can actively invest in development and thereby create the groundwork for its future growth in value.

That is why investors look not only at how much a company pays out, but also at where that money comes from, what the business’s financial results are, how much it invests in growth, and what its prospects are.

Are dividends the only way to make money on shares?

No. An investor can potentially earn income from shares in two main ways.

The first is dividends, if the company has decided to allocate a portion of its profits to pay them out.

The second is a rise in share price.

For example, an investor purchased 1,000 shares of “Coffee & Co.” at UAH 50 each. His investment totaled UAH 50,000.

After some time, the market price of the shares rose to 60 UAH. Now, 1,000 shares are worth 60,000 UAH. If an investor sells them at that price, the difference between the purchase price and the sale price will be 10,000 UAH — excluding taxes, commissions, and other expenses.

However, the opposite scenario is also possible: the share price could fall. Similarly, the company could reduce its dividends or stop paying them altogether.

Therefore, neither dividends nor an increase in the value of the shares can be guaranteed.

The main thing to remember

• A share is a security that grants its holder certain rights with respect to a joint-stock company.
• Dividends are the portion of a company’s profits that it has decided to distribute to its shareholders.
• The fact that a company makes a profit does not automatically mean that dividends will be paid.
• A company can retain its profits and use them for business growth, investments, debt repayment, or other needs.
• In order to pay dividends, a corresponding corporate decision must be made and the persons entitled to receive them must be identified.
• The amount of the payment depends on the number of shares held by the investor and the dividend per share for the relevant type and class.
• The law also provides for cases in which a company may not decide to pay dividends or make such payments.
• Dividends are just one of the possible ways to make profit from shares.
• Investment always involves risk: neither dividends nor growth in share price are guaranteed.