Investing in Dividend Stocks
Investing in dividend stocks may be considered as part of the goal to building long-term wealth. If you are interested in learning more about dividend stocks, this article may be helpful.
What are dividend stocks?
Dividends are a type of payment used by companies to share profits with their shareholders. Dividends may be paid out on a monthly, quarterly, semi-annual or annual basis, which is one way for investors to earn a return from their investment. This article can help you better understand dividend stocks.
What is a dividend?
Dividends are payments made by companies to their shareholders based on the number of shares they own.
Dividends are usually paid when a company has excess cash that is not being reinvested into the company. This excess cash is divided up among shareholders and paid out to them.
How do dividends work?
If a dividend is announced, qualified shareholders are notified through a press release, which usually includes the following information:
- The Declaration Date, which is the date the dividend is declared.
- The Record Date, which is when companies review the list of shareholders to determine who is eligible to receive the up coming dividend payment.
- The Payment Date, which is the day shareholders will receive the dividend payment.
- The Ex-Dividend Date, which is the date the stock no longer trades with the dividend. If you purchase shares on or after the Ex- Dividend date you are not entitled to the upcoming dividend payment.
Dividends are often paid quarterly, but can be paid out on other frequencies (or even as a one-time payment, for special dividends). The amount received depends on the number of shares you own in that company. For example, if you own 100 shares and are paid out $0.50 for every share, you may get $12.50 every quarter – or $50 annually.
To qualify for a dividend payout, you must be a “Shareholder of Record”. That means you must already be listed as one of the company’s shareholders on the Record Date. Dividend payouts are usually in relation to the overall financial health of the company, as well as the price at which their stocks/shares are trading.
When there is a high-value dividend, it may indicate that the company is financially healthy and pulling a good profit. However, high-value dividends may also point to signs that the company has no future projects planned and is using this cash to pay shareholders (rather than reinvesting it).
For companies with an established history of dividend payments, any significant reductions to the dividend amounts, or the elimination of dividends altogether, may be a warning about the company’s financial health. On the other hand, it might be a signal that management has a plan to reinvest that money into the growth of the company. That is why it is important to research the companies you’re considering investing in.
Reasons why someone may consider investing in dividend stocks
One of the reasons people choose to invest in dividend stocks is because of the continual flow of income it may offer.
Another reason is the tax credits Canadians may receive for their Canadians dividends.
For many dividend stock investors, a benefit is the Dividend Reinvestment Plan (DRIP). A DRIP is when investors take their cash dividends and turn them into more shares (rather than taking the cash). This may be considered by shareholders who want to acquire more shares without having to pay commission.
Since companies that pay out dividends tend to have good cash balances, they may be considered financially stronger than companies that don’t. This means that some investors may assume them to retain their value in case of an economic downturn, often making them preferred by investors with a low-risk appetite.
Things to consider when choosing dividend stocks
When deciding on an investment strategy, one way that may help add stability to a portfolio is by investing in reputable companies with a solid track record of dividend payments. However, a company’s historical track record of paying dividends does not guarantee they will continue to pay dividends in the future.
When it comes to choosing dividend stocks, it may help to understand the yield or the annual dividend per share price. This can give you a rough idea of how much income you might receive for each dollar invested in the company.
In some cases, some people may spend all their energy on what the dividend yields have been, rather than the fluctuation of the stock price. This is a very narrow view, since stock prices are related to a company's performance.
When a stock’s value grows, the demand for those stocks often goes up with it. And with the laws of supply and demand, when demand goes up, the price does too. Since the dividend isn’t directly related to the stock price, the dividend yield (calculated by dividing the annual dividends paid per share by the price per share) technically falls.
The payout ratio
The dividend payout ratio calculates dividends related to the company’s earnings. This may be an indicator of how feasible their dividend policy is. If their payouts are high (e.g., 55%-75%), it usually means over half their earnings are going towards dividends, rather than being reinvested. If the ratio is between 10%-30%, it’s often considered a modest dividend, which could signal that the company is putting their earnings towards growth.
Determining a company’s debt ratio is an easy calculation. Simply divide the company’s total debt (lines of credit, bank loans, etc.) by the company’s total assets (property, equipment, etc.). This type of information can usually be found in annual reports of publicly traded companies.
Remember, dividend stocks are not bonds, which guarantee the return of your principal. Bondholders are paid out of operating capital, whereas shareholders are paid out of profit. Because of that, dividend stocks are subject to macroeconomic and company-specific risks.
Look at their past dividend payout trends. Has it doubled over the last couple years? Or has it been slowly declining? How much has it been fluctuating, if at all? Get a hold of their annual report, spend some time on their website, and immerse yourself in their business model to help understand their growth plan.
However, there’s no guarantee that a company will pay dividends. Take 2020 for example. No one could see that coming. While companies with strong balance sheets are often able to successfully weather a slow economy, even some of the best businesses had to slash dividends during the pandemic in order to save cash.