Dividends are regular payments of profit made to investors who own a company's stock. Not all stocks pay dividends.
Dividends are payments a company makes to share profits with its stockholders. They're paid on a regular basis, and they are one of the ways investors earn a return from investing in stock.
But not all stocks pay dividends if you are interested in investing for dividends, you will want to specifically choose dividend stocks.
What Is a Dividend?
- A dividend is a share of a company's profits distributed to shareholders and usually paid quarterly, like a bonus to investors.
- "A dividend is cash in your pocket," says Nick Getaz, portfolio manager for the Franklin Rising Dividends Fund (ticker: FRDPX) at Franklin Templeton in New York. Unlike share price, which can change from day to day, once a company commits to paying a dividend, it's as good as guaranteed.
- Dividends are a way for shareholders to participate and share in the growth of the underlying business above and beyond the share price's appreciation. This sharing of the wealth can come in one of two forms: cash dividends or stock dividends.
In the U.S., most dividends are cash dividends, which are cash payments made on a per-share basis to investors. For instance, if a company pays a dividend of 20 cents per share, an investor with 100 shares would receive $20 in cash. Stock dividends are a percentage increase in the number of shares owned. If an investor owns 100 shares and the company issues a 10% stock dividend, that investor will have 110 shares after the dividend.
Dividends are not guaranteed. They're "at the discretion of the board of directors," says Scott Davis, senior portfolio manager and head of income strategies at Boston-based Columbia Thread needle Investments. Unlike a bond, which must pay a contracted amount or be in default, the board of directors can decide to reduce the dividend or even eliminate it at any time, he says.
Table Of Content
- What are dividend Stock?
- How Do they Work?
- Why Do People Invest In Dividend Stocks?
- How to evaluate dividend Stocks?
- Advantages & Benefits of Investing In Dividend Stocks
How Do Dividends Work?
- Essentially, for every share of a dividend stock that you own, you are paid a portion of the company’s earnings. You get paid simply for owning the stock!
- For example, let’s say Company X pays an annualized dividend of 20 cents per share. Most companies pay dividends quarterly (four times a year), meaning at the end of every business quarter, the company will send a check for 1/4 of 20 cents (or 5 cents) for each share you own. This may not seem like a lot, but when you have built your portfolio up to thousands of shares, and use those dividends to buy more stock in the company, you can make a lot of money over the years. The key is to reinvest those dividends!
Why Do People Invest in Dividend Stocks?
- Even though dividends aren't guaranteed, many investors rely on them as a source of income. Because companies pay their dividends at different times, retirees can create a schedule to receive a dividend check each month of the year, says Boston-based Bill McMahon, senior vice president and chief investment officer of active equity strategies at Charles Schwab Investment Management.
- Meanwhile, younger investors who may not need the income now can put those dividends to work immediately in their portfolios by reinvesting them. Dividend reinvestment plans automate this process, but even if you reinvest your dividends, they are still taxed the year you receive them. The exceptions are dividends in a tax-advantaged account like an individual retirement account, where the money grows tax-free until it's withdrawn.
- Dividends are a way for shareholders to participate and share in the growth of the underlying business above and beyond the share price's appreciation. This sharing of the wealth can come in one of two forms: cash dividends or stock dividends.
- In the U.S., most dividends are cash dividends, which are cash payments made on a per-share basis to investors. For instance, if a company pays a dividend of 20 cents per share, an investor with 100 shares would receive $20 in cash. Stock dividends are a percentage increase in the number of shares owned. If an investor owns 100 shares and the company issues a 10% stock dividend, that investor will have 110 shares after the dividend.
- Dividends are not guaranteed. They're "at the discretion of the board of directors," says Scott Davis, senior portfolio manager and head of income strategies at Boston-based Columbia Thread needle Investments. Unlike a bond, which must pay a contracted amount or be in default, the board of directors can decide to reduce the dividend or even eliminate it at any time, he says.
How to evaluate dividend Stocks?
An investor can use different methods to learn more about a company's dividend and compare it to similar companies.
- Dividend per share (DPS)
As mentioned above, companies that can increase dividends year after year are sought after. The dividend per share (DPS) calculation shows the amount of dividends distributed by the company for each share of stock during a certain time period. Keeping tabs on a company’s DPS allows an investor to see which companies are able to grow their dividends over time.
- Dividend yield
Financial websites or online broker platforms will report a company’s dividend yield, which is a measure of the company’s annual dividend divided by the stock price on a certain date.
The dividend yield evens the playing field and allows for a more accurate comparison of dividend stocks: A $10 stock paying $0.10 quarterly ($0.40 per share annually) has the same yield as a $100 stock paying $1 quarterly ($4 annually). The yield is 4% in both cases.
Yield and stock price are inversely related: When one goes up, the other goes down. So, there are two ways for a stock’s dividend yield to go up
The company could raise its dividend. A $100 stock with a $4 dividend might see a 10% increase in its dividend, raising the annual payout to $4.40 per share. If the stock price doesn’t change, the yield becomes 4.4%.
The stock price could go down while the dividend remains unchanged. That $100 stock with a $4 dividend might decline to $90 per share. With that same $4 dividend, the yield would become just over 4.4%.
For most stocks, a good rule of thumb is to carefully analyze anything above a 4% yield, as it could indicate the dividend payout is unsustainable.
However, there are some exceptions to this 4% rule specifically, stock sectors that were created to pay dividends, including real estate investment trusts. It's not unusual for REITs to pay safe yields in the 5% to 6% range and still have growth potential.
- Dividend payout ratio
Advisors say one of the quickest ways to measure a dividend’s safety is to check its payout ratio, or the portion of its net income that goes toward dividend payments. If a company pays out 100% or more of its income, the dividend could be in trouble. During tougher times, earnings might dip too low to cover dividends. Generally speaking, investors look for payout ratios that are 80% or below. Like a stock's dividend yield, the company's payout ratio will be listed on financial or online broker websites.
Advantages of Investing In Dividend Stock
- They offer Dual Benefits To Investors
Although dividend stocks do not have any higher growth potential than growth stocks, they do have the potential for value appreciation.
Investing in dividend stocks helps investors enjoy all the dual benefits such as value appreciation and consistent regular income.
For example.....
An investor can invest in a high dividend stock and soak the benefits for quite a few years. Later on, he can sell your investment to book handsome profit from his investment again.
- They Help You Fight Inflation
While the inflation rate is increasing day by day and making an upward trend, it’s essential to make effective and inflation-proof investments.
An investor can achieve this by investing in dividend stocks, especially in high dividend growth stocks.
Growing dividend yields will help you fight against the rising inflation rate and void it.
- They are Less Prone To Market Volatility
Investors do not have to spend their entire time and energy tracking the stock movements or other movements happening in the stock market with dividend stocks.
Dividend stocks are quite strong and stable companies that are less prone to market volatility and have fewer chances of wild swings in their price.
All an investor needs is a simple “buy and hold” approach to embark on the investing journey in dividend stocks.
- Great source of passive income
As we’ve already seen, that company offers high dividend stocks consistently and periodically distributes its profits to all the shareholders.
This gives them a regular source of income which is similar to the interest they get while keeping money for a longer time.
Just like band offers guaranteed returns on investments, dividend stocks also offer guaranteed returns to ensure that money is invested in the right place.
- They’re significantly less risky than others
High-dividend stocks don’t lose their value even there is a sudden market crash or decline of a particular event. As a result, they are safe compared to other growth stocks.
The best thing about dividend stocks is they gain back their value during harsh market movements, making them a reliable option for risk investors on capital protection.
These stocks, when added to the portfolio, help to diversify the risk potential effectively.
- Helps you Reinvest The Dividends
When an investor receives dividend payouts, they have the opportunity to use it for personal expenses or reinvest in the same stock.
Reinvesting in the same stocks by using dividend payouts can help investors deliver steady returns on their investment with the help of dividend compounding.
When investors continuously reinvest it’s dividend payouts in the stock market, it helps them boost returns effectively.