Investing: The Power of Dividends – A Beginner’s Guide
Dividends can be confusing investments. Are they good? Are they bad? (Well, that depends). What are they?
Nonetheless, By the end of this short report you’ll be a moderate-level “expert” on dividends and have a good idea of what’s really going on when a company pays dividends.
However, When a company earns a profit, it really only has two options:
‣ Buy back shares / pay back debt.
‣ Give that profit to shareholders (these are dividends).
Moreover, In the beginning of the twentieth century, companies were expected to pay dividends; it was the primary reason that investors purchased stock. That is not always the case now. In fact, most companies do not pay dividends – they would rather grow the business and reward investors through capital gains.
In addition, companies typically pay dividends only when they lack sufficient growth prospects.
Furthermore, Utilities are a good example of companies that usually pay a dividend. In contrast, your local water company can’t usually just decide that it’s going to supply water to an additional 50,000 homes next year.
Likewise, In all probability, it already supplies water to all the homes in the area. It is not easy to switch over homes that use another water company. Therefore, It’s simply difficult, if not impossible, for certain companies to grow organically. These are the companies that are most likely to pay a dividend.
The Board of Directors must declare dividends every time they are paid to investors. Three dates are critical to the process.
1. Declaration Date: This is the date the announcement is made that a dividend will be paid. Companies also announce the date of record and the payment date. The company creates a liability on its balance sheet on the declaration date, as it now has to make a payment in the future.
2. Date of Record: In a nutshell, whoever owns the stock on or before this date will receive the dividend. If you purchased the stock after the date of record, the person from whom you purchased the stock would receive the dividend. We commonly refer to this as the ‘ex-dividend’ date.
- Payment date: is the date on which shareholders receive their payment
Most companies pay the dividend out four times a year on a quarterly basis. Keep in mind, if you see that a company pays a $1.20 dividend per share, that’s $0.30 four times a year; that is
not $1.20 four times a year. There are a few companies that pay their dividend once a year, so be sure to check.
Many companies sell both preferred and common stock. With preferred stock, the dividends are usually set, so you know what you’re most likely going to get when you purchase the stock.
The board of directors sets the amount of dividends paid to holders of common stock, and the amount is likely to vary each time the dividend is paid out.
Companies may payout a one-time dividend; this is likely to be the result of a major court win or the liquidation of a major asset. Comparing Companies That Pay Dividends These financial ratios relevant to dividends will enable you to compare companies
‣ Dividend Payout Ratio: is the percentage of net income that a company distributes as dividends.
‣ Dividend Yield: If you divide the current or expected dividend by the share price, you will have the dividend yield. This number will tell you the expected rate of return you should receive in cash from your investment.
Dividend Reinvestment Programs (DRIPs)
Most of us can’t afford to purchase enough stock that the dividends amount to a significant amount of money. That check you receive for $20.37 isn’t going to go very far. That’s where dividend reinvestment programs (DRIPs) can make a big difference.
If you enroll in a DRIP, you won’t receive those checks anymore; your dividends will go directly back into your brokerage account to purchase additional stock. A big advantage for smaller investors is that most DRIPs allow the purchase of fractional shares.
So, if a stock costs $100/share and your dividend payout is only $10, you will get 1/10th of a share immediately instead of having the money sit for 2 ½ years in your account until you accumulate that $100 share price.