Dividend stocks can be an excellent option for individuals seeking investments that offer consistent income. Dividend stocks issue regular payments to investors based on a company’s earnings, typically every quarter. Less volatile than growth stocks, dividend stocks can also help minimize risks and diversify an investor’s portfolio.
- Dividend stocks typically dispense quarterly dividends based on a company’s earnings
- Dividends provide investment income or additional shares to shareholders based on a company’s profits
- Companies have many reasons for paying-out dividends, with each having their own implications and interpretations for investors.
- There are many reason companies pay out dividends, including as a way to reward shareholders for their trust and loyalty
What are Dividend Stocks?
If a company regularly pays out a portion of their earnings in the form of dividends, they have dividend stocks. These companies are typically well-established with a track record of paying out earnings to investors.
Dividends are managed and decided by the board of directors of a company and are approved by shareholders via voting rights. While cash dividends are the most common type of dividends, they can also be issued as other property or shares of stock. In addition to companies, various exchange-traded funds (ETF) and mutual funds also disperse dividends.
How Do Dividend Stocks Work?
Dividends are a popular investment income source for many investors. For the company issuing the stock, dividends are a way for them to share profits with their shareholders as a way to encourage them to buy more shares and thank them for their current support. Dividends also help publicize a company’s success as they are a direct result of their retained earnings, and only companies consistently profitable are able to pay dividends regularly. For example:
- Say a company has 1.5 million outstanding shares and has a $0.75 dividend, an investor with 200 shares receives $150 with the company paying out a total of $1,125,000.
- If the same company issues a 15% stock dividend instead, the same investor receives 30 additional shares with the company doling out 225,000 additional shares.
Why Companies Pay Dividends
There are many reasons companies pay-out dividends, each with their own interpretations and implications for investors.
Shareholders often expect dividends as a reward for the trust they have in a company. Company management looks to honor this trust by having a solid track record of dividend payouts as they reflect positively on the company and help ensure the confidence of investors.
Many times shareholders prefer dividends over capital gains from selling a share for a profit. Dividends are considered a tax-free income in many jurisdictions — investors who are looking for short-term profits often like receiving dividend payments offering immediate tax-free gains.
While high-value dividend declarations may indicate a company is performing well and generating good profits, they may also be an indication that a company doesn’t have adequate projects required to create better returns and are using its capital to pay stakeholders rather than reinvesting it back into the company.
A company with a long history of dividend payments in the past that suddenly reduces or eliminates dividends may be an indication of several things. When General Electric Co. (GE) announced it was decreasing dividends by 50% on November 13, 2017, investors also saw it’s stock price decreased by more than 7%. It may just mean that company management has other plans for investing the cash depending on its operations and financials.
Impact of Dividend Declarations on Share Price
Prior to distributing a dividend, the company issuing the dividend needs to declare several things, including:
- The amount of the dividend
- The date the dividend will be paid
- The ex-dividend date or the last date individuals can buy shares and be eligible to receive the dividend
Dividend declarations obviously encourage investors to purchase stock. Since investors know they will get a dividend if they buy the stock prior to the ex-date, they are often willing to pay a premium, which results in the stock price increasing as the ex-date approaches. Typically the increase is about the same as the dividend amount but based on market activity and not by any governing body.
Investors are likely to drive down the price of the stock on the ex-dividend date by the dividend amount. This accounts for new investors not eligible for dividends also not willing to pay the premium.
If leading up to the ex-dividend date, the stock market is especially optimistic about the stock. The price increase may be more than the dividend amount, which results in a net increase regardless of the automatic reduction. Reductions may not even be noticed if the dividend is small due to the normal back and forth of trading.
Important Dividend Dates
Dividend payments follow a chronological order with a set of important dates investors need to know and understand:
- Announcement Date – the date company management announces the dividend that has been approved by shareholders
- Ex-dividend Date – also knows as the ex-date, this is the date the dividend eligibility expires, meaning investors buying stock on or after this date won’t qualify for the dividend.
- Record Date – set by a corporation’s board of directors, this is the date investors must be on a company’s books and typically one day after the ex-date.
- Payment Date – the date the company issues dividend payments into investor accounts.
Metrics All Dividend Investors Need to Know
There are several important metrics associated with dividend stocks that are important for investors to know and understand:
- Dividend yield – expressed as a percentage and also known as the dividend-price ratio, this metric is calculated by dividing the dividend per share by the price per share or dividing a company’s annual dividend payments by its market capitalization.
- Payout Ratio – shows a company’s ability to continue paying dividends even if profits decrease and is calculated by dividing dividends by net income.
- Total Return – an overall performance picture of a dividend stock; this is a combination of share price appreciation and dividends. For example, if a dividend stock increases by 7% this year and pays a 4% dividend yield, its total return is 11%.
- EPS Growth – or Earnings Per Share growth is calculated by subtracting EPS for the previous year from EPS for the year just ending. Divide this number by the previous year EPS, then convert to a percentage by multiplying by 100. A high EPS is a good indicator that a stock is consistently growing and able to increase its dividend.
- P/E Ratio – probably the most-used metric used by investors, the P/E ratio is calculated by dividing the current price of a stock by its EPS and is generally used to evaluate mature companies and important for comparing dividend stocks.
How to Buy Dividend Stocks
Companies paying dividends are usually more stable and mature than those that don’t. While dividend-paying companies won’t likely skyrocket immediately, having a solid portfolio of dividend-paying stocks can result in a large amount of wealth over time. Understanding how to buy dividend stocks is the first step:
- Research quality stocks with lower volatility
Think about the products you currently use and companies and brands that have missions you agree with. Some of the highest dividend-paying stocks on the market today include Apple Hospitality REIT (APLE), Apple Corporation (AAPL), and Equinix (EQIX).
- Read the stock’s quote
A stock’s quote summarizes key information needed before investing and can be found by entering a stock’s ticker on most online stock and financial news providers, including NASDAQ.com, Google Finance, and Yahoo Finance. Information on how much the stock paid out the previous year can be found under the “annualized dividend” or “dividend” sections.
- Purchase the stock
Investors can purchase stock either directly through the company or via a broker of their choice. Purchasing directly through a company may require investors to make a $25 to $500 minimum investment depending on company policies and individual share price. Investors not wanting to make a minimum purchase through the company may elect to go with a brokerage firm.
- Collect or reinvest dividends
Investors have two options available to them for collecting dividends, receiving a cash payment, or reinvesting back into the company via a dividend reinvestment plan (DRIP), which automatically reinvests dividends into more stock shares.
- Track your dividends
Since companies aren’t required to pay dividends to shareholders, they can choose to eliminate, raise, or lower them at any time. This makes tracking dividends important so investors can make informed decisions as to when it’s time to sell stock that’s no longer performing as they want.
Dividend stocks help investors diversify their portfolio while offering consistent investment income. To understand how dividend stocks can help your investment account grow, schedule a free training session with one of Raging Bull’s team of millionaire experts today.