What Is a Dividend?
A dividend is a distribution of a company's earnings to its shareholders. Dividends are typically paid out quarterlyand they can be in the form of cash or stock.
Dividends are one way that companies can share their profitability with their shareholders. When a company earns profitsthe board of directors has the discretion to decide whether to distribute those earnings to shareholders in the form of dividends.
Some investors prefer companies that pay dividends because they provide a source of regular income. Additionallydividend payments can signal that a company is doing well financially.
Howeverit is important to remember that not all companies pay dividends. Some companies may reinvest their profits back into the business instead of paying them out to shareholders.
Andeven if a company does pay dividendsthe amount can fluctuate from year to year.
What Is the Dividend Yield?
To calculate the total dividend for a companydivide the per-share dividend by the market share price. In this examplethe share price is $32and the firm distributes $1.75 per share. The payout ratio is 0.054 percent or 5.4%.
Because the dividend yield is based on the share price when you buy plays a crucial role in dividend investing.
You want to buy during moments of irrational volatilitylike when stock prices may drop lower than they should be– this creates an incredible opportunity.
Let us say the stock price drops from $32 to $27; if that happensthe yield will jump to 6.4%.
And remember: as long as you own that stockits original owner will keep paying the same amount for it regardless of any changes.
Why Do Firms Pay Dividends?
This is a reasonable concern. When a firm makes moneyit can utilize it in various ways.
One choice is to reinvest profits into the company's growth by acquiring better equipmentmarketingand research and development.
If a firm decides to save its earningsthey are referred to as retained earnings.
Retained earnings are an excellent indicator of a company's health in the same way that dividends are. In essencethey are identical.
- Sometimeswhen a company's costs for doing business are fixedholding onto cashbuying new technologyor raising money for upgrades is not a top priority
For exampleonce the capital has been spent to lay a pipeline or create infrastructurea natural gas transmission company's future profits can be paid out to investors since their return from the transmission business only increases with time. - Recentlythe CEO of Sirius (satellite radio) gave a similar reason. He said that at the end of the yearhe would be sitting on a billion and a half cash stash with no plans to spend it because all their programming contracts had been renewed.
Additionallythere were no other companies on the horizon to acquire. Insteadhe hopes the board will hand out a special dividend--a non-recurring bonus paid to shareholders when profits are booming. - Companies pay dividends to show financial stability and attract more investors. In other wordsthe company's stock becomes more desirablelowering the interest rates they have to pay on loans - saving them a lot of money in financing costs.
- A company's dividend rate is a good indicator of its prospects. If a company increases its dividendit shows that the board and officers are confident in the company's ability to make money in the future.
On the other handcompanies never want to cut dividends because it looks terrible and makes management look incompetent. - The final reason is apparent: Profits are intended for the shareholders. Shareholders can elect to have management distribute funds as they please.
The Payout Ratio: Why It Matters
The payout ratio is the proportion of earnings that a firm distributes in dividends. For examplesuppose a business makes $100,000 in net income and pays out $70,000 in dividendsyielding a payout ratio of 70%. That is relatively high.
To figure out the proportiondivide the total dividend paid for the year by the total net income (70k/100k).
Pro Tip: The payout ratio is included in most financial reports.
Why are Payout Ratios So Important?
Payout ratios are significant because they symbolize a number of crucial aspects for investorsincluding:
- the probability of a dividend increase
- the working capital available to finance business expansionsand
- the consistency of future dividend payments.
The Ideal Configuration for a Dividend Investor
You are in good shape if you get a high yield (above 5%) and the payout ratio is low.
Those figures suggest that the company will be able to continue to pay decent returns while remaining competitive by having enough cash (50% of retained earnings) to invest in future income generation.
It's also less likely that such a firm would cut dividends (even during severe economic downturns). At the same timeas sales growit becomes more likely that firms with a lower payout ratio will increase their dividends.
Pro Tip: A 100 percent payout ratio is typical for a Ponzi scheme.
What is the Procedure for Dividend Payment?
Dividends are divided into shares. As a resultthe more shares you ownthe greater your return.
On the other handall investors receive the exact yield for each share. Of coursebig money players like Warren Buffett may buy $5 billion in Goldman Sachs with a 10% yield and warrants to acquire a few billion more at an even lower rate.
Most retail investorson the other handreceive exactly what is advertised.
What is the Definition of an Ex-Dividend Date?
You will not receive a dividend payment if you buy a stock after the ex-dividend date.
That is all there is to it. Before that dateyou must be sure to purchase stock. The ex-dividend date is one business day before the date of record.
Different Types of Dividend Payments
Companies pay out their dividends in different ways depending on their business model or board of directors' decision.
The four most common methods are cash dividendsstock dividendsstock splitsand property dividends.
Cash Dividends - dividends are paid in cash. To paya company must have cash on hand. This could possibly mean that the firm is healthy and ready to face any emergency. Most investors would obviously want to be paid in cash instead of stock.
Stock Dividends - dividends paid out of stock—instead of cash—are known as stock dividends. In this scenariocorporations can keep their money. If a firm decides to switch from paying in cash to paying in stockit might be a sign of trouble.
That decision indicates that a company's free cash flow may be restricted.
Stock Split - A stock split is when a company divides its existing shares into multiple new ones. This has the effect of reducing the value of each sharebut it also makes it more affordable for investors to buy more significant numbers of shares.
Splits are usually undertaken when a company's share price gets too high and becomes unwieldy or unsustainable.
Property Dividends - dividends paid out as shares of a subsidiary firm or actual assets such as real estateinventoryor anything tangible. The corporation's dividend value is based on the fair market value of the underlying asset.
If a business does not have adequate cash on hand or does not want to dilute the parent company's stockit can choose to do this.
Dividend Income's Advantages
Dividend income has a number of advantages that make it an attractive investment optionespecially in comparison to other types of investments. These advantages include:
Lowering Risk: Companies with high yields are less likely to be damaged by economic fluctuations because they can temporarily lower dividend payouts to maintain their operations.
Growth stockshoweveroften collapse during recessions because they tend to be leveraged when these months occur. Without a bufferthese companies cannot absorb the blow.
Moreoverduring economic contractionsthese companies continue to pay high yields. This gives investors income even in the weakest market conditions.
The primary reason dividend stocks can keep giving returns during recessions is that consumers have a list of necessities they are willing to cut back on last. These include items like utilitiesgasgroceriesand phone serviceall sectors with excellent yields.
Tax Advantages: This is one of the two advantages of owning dividend stocks. In 2012when Republican presidential candidate Mitt Romney released his tax returnsthere was widespread controversy and disbelief.
Although Romney earned over $44 million in just two yearshe only paid an effective rate of $14%.
Comparativelythe average middle-class worker pays between 25-35%. The reason for this discrepancy is that Romney's income largely came from dividendsinterestand capital gains--all of which are taxed at a much lower rate.
Investors need to know if the tax break will continue due to the significant disparity. Pursuing an investment strategy is only advantageous if one of the major advantages would not be taken away.
Howevereven if congress passes the Buffett Rule (which is very likely)it would not affect most investors.
The measures proposed by the White House state: Those making over a million dollars a year must pay a minimum effective tax rate of 30%.
The Buffett Rule is similar to the Alternative Minimum Tax (AMT). The Buffett Rule is a policy that would equitably implement reasonable rules and would not disadvantage people who give large amounts of money to charity.
The Alternate Minimum Tax (AMT) is comparable to the Buffett Rule.
What Are the Tax Implications of Foreign Income?
It is hard enough to pay taxes oncebut paying twice is just cruel. As a resultdouble taxation of dividend income might be frightening if you consider a portfolio of foreign equities. Howeverthere is no cause for worry yet.
If you are subject to a 15% foreign dividend income tax in Brazilyou can usually claim a credit for the entire amount when you submit your tax return in the United States.
Of coursecredit availability depends on the investment vehicle used to invest in foreign assets.
Soperhaps some research or consultation with a tax professional would be helpful.
For examplethough the income you gain from dividends qualifies for a credityour labor does not. The United States is alone in this sense among industrialized countries- it taxes the money you make overseas even if you already paid income tax there.
This rule again preferential treatment of dividend/interest income under the law.
What Kinds of Assets Pay Dividends?
Yield-seeking investors might be attracted to dividend stocks regardless of the sector or industry. Stillit is essential to remember that the same due diligence is required when assessing these companies.
Dividends are simply distributions of profitsso prospective dividend stock investors should get to know a sector or industry before investing. This will increase your chances of making good bets on future prospects.
Consider an area of expertise in the investing universe. If you are a dividend investorthere are many ways to maximize income from your investmentsbut you still have to be able to judge the current and future prospects of any stock you wish to buy.
You have advantages in picking stocks.
For exampleColtene Holdings would be an excellent investment for dentists because they are in the best position to assess which companies in their industry are cutting-edge and well-managed.
If you work in the gas industryyou have a unique perspective on how close we are to pass a natural gas bill by Congress. You also know about the cycles that gas prices go through. In March 2012natural gas prices were at their lowest in 10 years.
Why is this? If you follow the industry closelyyou would know that it is because of something called fracking - a new technology that allows producers to drill deeper into the Earth and tap into previously unreachable reserves of natural gas.
Peter Lynch argues in his bookOne Up on Wall Street that we as individuals have the upper hand over Wall Street because we see things from the bottom up rather than from the top down.
He stated that by the time trends reach analysts on Wall Streetthey would have missed out on most small-cap growth stocks.
For examplecountless people knew about fracking when it was still only a concept. Gas stock prices would have been wise to short once fracking became an actual technology.
The Different Types of Dividend Investments Strategies
Dividend investment strategies are as diverse as the investors who use them. This is beneficial because it allows each dividend investor to tailor their strategy to fit their unique needs and goals.
The following are some popular dividend investment strategies:
Offsetting Trading Losses: Investors frequently seek dividends-paying assets during expected sluggish stock development periods. The idea is that the dividends will compensate even if the market fails to advance.
This is why electricity stocks with high payout rates are bid up during economic uncertainty.
For examplethe value of one share (CLP Holdings)which pays a 6% yieldrose from $8 to $9.17 as money managers rushed into utility companies seeking safety. When volatility decreasedit returned to $8/share.
Return on Capital: Ideallyyou should concentrate on firms with a track record of increasing dividends located in fast-growing industries. You want to keep these stocks long-term and reinvest the dividends.
The rate of return on your original investment to acquire the underlying asset will rise with time as dividends rise over time. For exampleif you purchase Natural Gas Inc. at $10 per share that pays $1 per share yearlyyour ROI is 10%.
But let us look at what happens to your return when dividends increase.
If Natural Gas Inc. increases dividend payments to $1.50 in the next five yearsyour ROI will be 15%. In other wordsif you invest $10/share todaythat is a fixed cost while the return from the investment (dividends) continues to grow.
Currency Strategies: It is easy to get caught up in percentage points when discussing yieldsbut we must remember that percentages do not always indicate value.
A 7% yield sounds excellentbut how much is it actually worth? With a global economyit becomes increasingly important to understand the currency we will be paid in and whether that currency will appreciate or depreciate over time.
Most investment books do not discuss this topic extensivelybut it is crucial to understanding the market.
We should not think that all dividend yields are the samejust like we would not assume that salt water and spring water are equally desirable simply because they are both liquids.
The notion that "a share has a certain value" is a myth. The percentage might be correctbut what good does it do? If the Dow rises 15 percentbut the dollar falls 15% simultaneouslyno real money has been made.
Intelligent investing can be described as understanding and keeping track of how conditions change over time. A good investment is not only based on the current market but also on how other investments are doing (including currencies).
Any investment process that does not take into account currency strategy is likely to fail. Ask your investment advisor or financial planner what their current strategy is this week--you might be surprised by the response.
Low or no fee investing: Many firms provide a dividend reinvestment plan. DRIPsfor shortare programs that enable investors to buy stock directly from the company without paying a broker fee.
The dividends are automatically spent on more of the stock. These fees make a significant difference in your portfolio's overall performance.
According to a study published in the August 272010 edition of The Wall Street Journalhigh-cost vs. low-cost mutual funds have differing rates of return.
According to the researchlow-cost mutual funds outperformed higher-cost counterparts by approximately 1.3 percent.
So not only would you be paying a more significant feebut your portfolio would also underperform by 1.3%. The majority of management fees range between 1 and 2 percent. DRIPS save you at least 1.3% each year on average.
So what is the big deal? Here is where it gets interesting: If we invest and compound our money at a rate of 10%we end up with $33,033 after 25 years (1 + 0).
Within 50 yearsour portfolio would be 80% more valuable if we save annually! A DRIP plan saves your money and grows it over time.
Pro Tip: Most companies have information about their DRIP plans on their websitesusually in the investor center.
InflationDividendsand Total Returns
Most investors miscalculate two key ideas: the effects of inflation on total returns and the power of dividends.
An article by Morgan Housel of the Motley Fool emphasizes the importance of dividends and their substantial influence on total returns.
- Although the Dow has increased by an average of seven point four percent since 1950if you adjust that number for inflationthe total is only three point three percent.
- Investors often underestimate the power of compounding interestHousel explains. Not only do dividends reduce the effects of inflation on earningsbut they also increase gains exponentially.
To make this point more precisehe compares the return on investment for stocks when dividends are reinvested and when they are not.
(a) Pfizer: If you had invested in this company in the 1960syour investment would have returned 4200%. Howeverif you reinvest dividendsyour return could be as high as 13,200%.
(b) Johnson and Johnson: Since the 1960sit has repaid 9700 percent. If dividends were reinvestedthe return would increase to 21,400 percent.
(c) Reynolds: Over the last two decadesits value has nearly tripled. The appreciation is 840% when dividends are reinvested.
In another articleHousel compared the return of Public Storage stock with and without dividends reinvested. He found that over twenty yearsthe difference was significant.
In the last four decadesthe stock has jumped 700%. And if dividends were reinvestedit would have come back with 4500% interest. The difference is astounding.
Quick Start Files
Here are all the files you need to get started with Proof:
Please Note: The following are not investment recommendations. They are merely examples of the processes and details involved in dividend investing.
(1) Coltene Holdings AG - the Swiss Franc will almost certainly continue its long-term appreciation against the dollar.
In 2004one franc was worth $0.82. Today one franc is worth $1.01. Investors who sold dollars for francs in 2004 may acquire more dollars today (as well as anything else denominated in dollarssuch as foodautomobilesor property).
A second benefit of holding Franc-denominated assets is that it has long been a safe haven for investors.
So even if the Swiss stock you own falls alongside the rest of the market during recessions or periods of uncertaintyyou are still making money since the franc will also rise.
The third consideration is that it was paying a decent return of 4.44%. The current dividend rate of Coltene is $.083 quarterly or $3.32 annually. The current share price is $74.
(2) Telstra is an excellent choice for investors looking to bet on large-cap communication companies. Telstra trades at $3.74 and pays out 6.68%. In additionTelstra has 3.793 billion dollars of free cash flow which helps to reduce risk.
Free cash flow is the money companies have after paying for the cost of doing business. Owning Telstra also provides exposure to the Australian dollarwhich can be beneficial in diversifying one's portfolio.
The examples presented should demonstrate that there are many bargains out there if we seek them. Furthermoresafety and yield are not mutually exclusiveas evidenced by these instances.
You may have your cake and eat ittoo; companies that pay strong dividends clearly have the financial wherewithal to do so.
Because a firm has money on hand to retool itself for future growthdividends act as a safeguard against the stock's full devaluation.
Asset Allocation for Dividends
You do not want to be concerned with yields when developing a portfolio. Instead of focusing on a losing companyfocus on a company with a competitive advantage that can withstand the competition.
To achieve diversificationyou should select a class of cyclical dividend-paying assets and compare it to its counterpart.
Its commonly believed that counter-cyclical stocks are difficult to find because businesses usually struggle when others around them are doing poorly. Howeveras CLP Holdings and utilities demonstrated earlierthat is not always the case.
While finding stocks that grow during economic depressions can be challengingthere are some companies whose stock prices increase during those times.
In other wordsthe movement of large amounts of money can cause a company's stock to increase even if the underlying business is not growing. Utility stocks gain during depressions and fall during booms. It is all about the flow of funds.
Finallyyou want a diverse currency portfolio. You want to be exposed to currencies from AsiaAustraliaNew Zealandand Canada. All of these countries have government debt and robust economies.
As the United States and Europe continue to deal with high debt levelstheir currencies will fall in value.
List of Resources
The following is a list of resources for dividend investing. This list includes bookswebsitesand podcasts.
1. Discount Brokerages: If you are a member of a trading platform like FidelityTD Ameritradeor Schwabyou have access to great research tools that can help you screen stocks from all over the world.
Get a broker to work for you on a low-cost basis: If you want to get information about these platformsyou can call their brokers. Many of them offer free classes on topics like stocks and options at local offices.
2. Alsobroker-assisted trades are affordableoften costing a flat $150 per trade. Brokers are still valuable. Do not believe that everyone has access to the same information simultaneously.
3. Utilize the Power of Crowdsourcing: With countless investors sharing their investment insightsadviceand investigation on a single platformall that information is crowdsourced (thus the name).
In the pastWarren Buffett would spend hours paging through Moody's manuals to find suitable investments. Howevernow bargain shopping is much simpler.
Thereforecrowdsourcing has become a favorite preliminary research method. Listed below are some websites to assist you in beginning your research process.
- Seeking Alpha: The website is a community of investors who share their findings. This is recommended for beginners who are starting to invest.
Go to the main webpage; on the right-hand sideyou will see a search box near the top.
Type in "yield" and press enterwhich will direct you to an article discussing high-yield utility stocks. Thenclick that link which takes you to different stocks that meet a certain set of criteria established by the author.
Atlantic Power Corporation looks stellar on paper at the top of the list. It has a yield of 8% and a low payout ratio. That is an incredible find. It could be a great investment. And it is all available for free.
- Motley Fool: This website contains a wealth of good articles written by independent investors. You can also find newsletters (some freeothers paid) that offer research on topics like dividendsgrowthand international investing.
- Google/Yahoo: This tactic may not be as exactbut it is still effective. If you search for "high yielding stocks" on Yahooone of the first hits will be a Forbes article.
From thereyou will find a website with a slide show that discusses Southern Copper-- which yielded 8.1% when the article was published. Simply branch out to create a list and open up the company's financials afterward.
- Reuters.com: After you have found a company you want to researchlook up the stock on Reuters.com. This website is easy to navigate and find what you are looking for.
You can access financialsnews reportschartskey developmentsprice dataand purchase analyst reports (usually costing between $10-$100).
- Reviewing company financial reports is the next step: By reading these documentsyou will get a feel for how management feels about the future of the company and what sort of challenges and opportunities they are facing.
This knowledge is key to making an informed investment decision.
- Get Yahoo Finance on Your Smartphone: The Yahoo Finance app is a helpful way to follow stocks you are interested in and get news related to those stocks.
The app filters financial informationso you only see what is relevant to your portfolio. And sometimesyou find answers to questions you did not even know you should have been asking.
Over timeyou will grasp how the stock market works by adding stocks you are interested in into your Yahoo app portfolio.
This wayyou can follow current news related to those businesses without searching for them. In additionYou will learn more about the company's issues and opportunities and find out information about its competitors.
- You can obtain the Mises Institute's texts for a small donation to their Free Market Education organization.
Though some of their pieces may be somewhat political in naturethere are several free economics audiobooksebooksand lectures available. You may read these ebooks on your Kindle for free if you have one.
The audio files and movies are ideal for students who do not have a lot of time on their hands.
- For information on inflation that is more accurate than what the government reportscheck out Shadowstats.com.
Most people are unaware that true inflation (which used to be measured before) is a little over 8%.
Given that inflation plays a part in why someone would own dividend-paying stocksit behooves investors to understand how it is calculated. - Dividend.com is a partner website of Jim Cramers TheStreet.com and is full of material. Has a lot of articles on the marketas well as a list of high-yielding dividend stocks.
Their list of high-yield dividend stocks has 1,627 firms starting with a yield of 24 percent at the moment.
Remember to keep an eye on things like nominal return rates; they may be deceptive in some cases.
Find out what is causing it to be so big. What is the payout ratio? Anything above 60% implies that dividends are at risk of being reduced sooner or later.
It is not guaranteedbut your security decreases dramatically as the payout ratio rises.
What Is a Dividend in Finance?
The money used to pay dividends comes directly from the income of a company. There are many reasons why a company might choose to pay out this money to investors instead of spending it elsewhere.
Primarilydividends are paid when a company is earning a significant income and has no reasonable use for the funds remaining after paying other dues.
This occurrence is rare in smaller businesses or businesses that are investing in rapid growthbut common in corporations with good cash flow that have reached a titanic sizesuch as Walmart.
With nowhere left to open new stores and a production rate that more than meets demandWalmart uses some of its excess cash to pay dividends as a reward to its many investors.
Some companies have grown their dividend payments for over 25 consecutive yearsand are called dividend aristocrats.
A company's dividend sustainably is of paramount importance to investors. Dividend sustainably is how likely it is that a company will be able to maintain or increase its dividend payments.
There are two metrics used to calculate this: dividend yield and dividend payout ratio.
Dividend yield refers to the percentage of the share price that gets paid back as a dividend. For exampleif shares sell for $10 each and pay a $0.20 annual dividendthen the dividend yield is 2%.
Dividend payout ratio is the proportion of a company's earnings that is used to pay dividends to investors. For exampleif a company earns an estimated $1 per share and pays the same $0.20 per sharethen the payout ratio is 20%.
The higher the percentagethe more likely it is that it will be reduced down the line.
Smaller ratios are less taxing on a company and reducing them has diminishing returnsso they are more likely to remain stable and sustainable.
How Are Dividends Paid?
Dividends are primarily paid to investors as cashbut some companies allow the dividend payment to be reinvested as additional partial stock in the company.
This is called a Dividend ReInvestment Planor DRIP. This can be especially appealing for investors looking to maximize their returns over time rather than benefit from short-term gains.
Important Dates with Regard to Dividend Payments
There are four important dates that dividend payments have:
- The declaration date
- The payment date
- The record date
- The ex-dividend date
The declaration date is simply when a company declares that it will be making dividend paymentsand the payment date is when the company sends the payment out.
The record date determines a recent share-buyers eligibility to receive a dividend payment for that period. Stock market rules say that the buyers must have purchased the share at least two days before the record date to receive payment.
The ex-dividend date is the date after which the traded share will not pay a dividend to its new owner. After this datethe next payment will be made to the original owner.
Final Thoughts
A Dividend is a distribution of a company's earnings to its shareholders. It is paid out quarterly and is often reinvested in the company. It also provides income for investorswhich can be helpful in retirement planning.
With a little bit of researchyou can start receiving dividend payments from the companies in which you invest. The key is to find goodsolid companies that have a history of paying and increasing their dividends.
Alsokeep an eye on the payout ratio; anything above 60% is cause for concern. Dividend stocks can provide you with a source of income that can help you reach your financial goals.
Dividend-paying stocks have outperformed the rest of the market for a reason: There are dependable investments that will continue to provide you with earnings even when other aspects of your portfolio might dip in value momentarily.
By following the steps outlined in this articleyou will be well on your way to growing your wealth and begin receiving payments from the companies in which you invest.
Most importantlyhave fun and take your time learning.
Dividend FAQs
A dividend is an amount of money paid by a company to its shareholders.
Quarterly is the most common frequency of paymentbut a company can also choose to pay monthlysemi-annuallyor annually. Dividends can alternatively be “special,” meaning that they are a one-time payment that won’t repeat (or won’t repeat at the same amount)but more often dividends are paid on a schedule.
Primarilydividends are paid when a company is earning a significant income and has no reasonable use for the funds remaining after paying other dues.
The money used to pay dividends comes directly from the income of a company.
Dividends are primarily paid to investors as cashbut some companies allow for the dividend payment to be reinvested as additional partial stock in the company.
True Tamplin is a published authorpublic speakerCEO of UpDigitaland founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®)author of The Handy Financial Ratios Guidea member of the Society for Advancing Business Editing and Writingcontributes to his financial education siteFinance Strategistsand has spoken to various financial communities such as the CFA Instituteas well as university students like his Alma materBiola Universitywhere he received a bachelor of science in business and data analytics.
To learn more about Truevisit his personal website or view his author profiles on AmazonNasdaq and Forbes.
