I often hear these two terms used interchangeably but they have very different meanings. What I’d like to do is clear the air. After reading this, you will see the difference between a dividend vs interest.
Defining Dividends and Interest
Dividends are a sum of money paid by a company to its shareholders regularly as a portion of profits. This means if Company X makes a profit, in order to reward shareholders in their faith for the company, Company X will pay them a dividend.
Interest is the amount of money paid as a fee at a predetermined rate for borrowing money or delaying the payment of borrowed money. Often types, similar to individuals, companies will borrow money in order to grow their business. They will pay interest to a lender for the right to use the money with the stipulation that they will pay back the borrowed money and include an additional fee (interest) at a specified rate for the privilege.
Dividend % vs Interest %
If your investment appreciated 8% over the course of the year, this will mean that your overall investment went up 14% because your investment appreciated 8% + 6% (dividend).
Interest percentage is the amount the company has to pay to lenders. If Company Y borrowed $40 million dollars at 3%, they will have to pay 3% annually on the balance remaining each year.
So if Company Y borrowed $40 million dollars and didn’t pay any of it back over the course of the year, they would pay $1.2 million dollars in interest for the privilege of borrowing the money and it would be added to the overall debt.
Relationship of a Dividend vs Interest in Regard to Profit
A dividend is a portion and product of profit. In order to give a dividend to shareholders, generally a company must be profiting. If a company made $200 million this year, they may take $3 million of that profit and split it among the shareholders in the form of a dividend. Some companies offer a fixed dividend where regardless of the amount of profit earned, the dividend remains the same. This creates a stable payout to shareholders that becomes predictable.
Other times, companies issue dividends based on the profit of the company. If they have a better year, they raise the dividend and if they have a disappointing year but are still profitable, they may lower them. This helps a shareholder measure the company’s strength and outlook.
Interest on the other hand, goes against profit. If a company made $200 million this year in profit but pays $1.5 million in interest, they were only profitable $198.5 million. It cuts out of their profit.
Here’s a good way to look at it. If a company made $200 million, they may pay $1.5 million in interest. That brings them down to $198.5 million in overall profit. They reinvest $170 million into the company’s research and development, spend $20 million in a new advertising campaign and decide to issue $8.5 million to the shareholders as a dividend. In this case, $8.5 divided by $198.5 is a little over .04 so the company paid out about a 4% dividend.
Are They Tax Deductible?
In short, dividends are not tax deductible and for interest there is usually a tax incentive. Since interest MUST be paid, this doesn’t really matter as affect whether a company will choose to pay it or not.
For dividends though, taxes may influence whether to issue a dividend and if so, how much.
Where Can I Find Stocks That Pay Dividends?
There are many stock brokers which have screeners built in that allow you to sort stocks by different criteria. One of those criteria is Dividend Yield %. Webull is one that I’ve reviewed before that makes it easy to identify High Yield Dividend Stocks. You can read my full Webull Review for more information on the benefits of Webull.
Bring It All Together
So as you can see, dividends are a portion of company profit that is shares with the shareholders. Interest is a fee paid by a company for the privilege of borrowing a larger amount of money from a lender. You should now know the major factors that make these two terms different.
If you would like to see the historical data on dividends issued or see the dividend yield and dividend ratio equations click here.
If you still have questions, please feel free to leave a comment below and I’ll try to answer your question as soon as as I have a chance.
Until next time, let’s start investing!
Eric Baglio has been investing for over ten years and learned a lot of valuable lessons along the way. He has helped numerous people start investing on their own and founded Let’s Start Investing to help anyone willing to learn how to build wealth. His favorite brokerage is Webull and his favorite stock advising service is Motley Fool Stock Advisor.