What Does It Mean to Reinvest Dividends?

US companies have the option to offer dividends (aka cash for corporate profit) to their shareholders. Who doesn't love passive income? Reinvesting dividends can put your financial goals on the fast track.

First, what are dividends?

Dividends are portions of a company's profits distributed to its shareholders for either preferred or common stock. The company's board of directors determines these dividends and pays them out to shareholders as a reward for investing money into the venture.

These dividend payouts are usually accompanied by a rise or fall in a company’s stock price, depending on how well the earnings per share (EPS) performs.

The voting rights of a stock determine dividends. Cash dividends are the most common, but some companies also offer dividends in the form of stocks.

Companies sometimes also issue non-recurring special dividends, either on an ad-hoc basis or in addition to regular dividends. For example, in 2004, Microsoft (NASDAQ:MSFT) declared a special dividend of $3.00 per share, above the expected quarterly dividend that was in the range of $0.08–$0.16 per share.

Look at a stock's dividend yield on its chart to find out if it offers earnings payouts.

How reinvesting dividends can compound investment returns

If you're building money for retirement or other financial goals, stocks that provide dividends are an excellent solution.

You can reinvest these dividends straight into your position by buying additional fractional or full shares. When combined with long-term compounding interest, this accelerates your financial goals.

By putting back your dividend income into these stocks, you can increase the total net worth of your assets and your annual returns.

Dividend reinvestment has proved to be particularly lucrative through compounding, including in the Middle East. In Gulf News, Dan Dowding, senior executive officer of Killik and Co. in the Middle East and Asia said, "Equity income investing is not just about receiving the income, but reinvesting the income received and allowing the power of compounding to drive their total return."

How to automatically reinvest dividends

Some brokerages let you automatically reinvest your dividend income back into the position. This is called a Dividend Reinvestment Plan (DRIP)—where cash can be put back into fractional or full shares of the underlying stock on the dividend payment date.

Usually, there's an option to check the "automatically reinvest dividends" box, though the wording may be slightly different.

If you set up a DRIP via a brokerage firm, you may be charged a commission fee for each investment (if you have shares with the fund company, it may be free).

Does every stock have a dividend?

Not all public companies offer dividends. Companies that don’t offer dividends usually reinvest their profits into company growth, leading to more significant increases in stock prices and creating additional value for investors.

One of many examples of US dividend stocks is BlackRock Inc. (NYSE:BLK), which earns 1.89% per $888.20 share as of Aug. 5, 2021. The last annual payout amounted to $16.52, a dollar value that adds up over time—especially when combined with returns.