Dividends are payments that corporations make to people owning their shares. It is undoubtedly one of the best reasons why people buy equity, and it’s the company’s best way to reward its shareholders. Many public companies that make money will retain portions of their earnings and pay the rest out as dividends to all shareholders. Most of the time, there’s a regular schedule to these dividends (quarterly is a popular schedule) but some companies pay one-time special dividends to shareholders when business is booming that is irregular.
Dividend Increases and Cuts
If business is strong, there is the general expectation that dividends will increase along with its earnings and stock price. Some companies, like Proctor and Gamble, have a proven track record of consistent dividend payout increases. This helps investors because not only are they reaping the rewards of growth in its stock price, it can also count on the dividends being increased.
When the company’s earnings power deteriorates however, they are forced to cut its dividend. This is obviously not a good sign, and the announcement of such news will usually knock down the stock price immediately.
In recent times, the government has mandated that certain financial institutions cut its dividend in order to receive substantial funding. This is obviously an anomaly and shouldn’t be read as that government will usually interfere with the decisions of dividend payouts in general.
The Dividends Metrics that You Should Know
While the most important number (and the one that companies announce) is the actual dollar amount of the dividend for the next payout, there are a few other important metrics that you need to be familiar with.
Even though companies announce the actual dollar amount of each dividend, everyone is more interested in the percentage of the yearly payouts with respect to the stock price. For example, if a stock is worth $100 per share and it pays $3 dollars in dividends last year, the dividend yield is 3%.
Dividend Payout Ratio
This is the portion of the earnings that is paid to shareholders. It is important as calculating the dividend payout ratio of previous earnings will give you a gauge of what the future dividend will be; while calculating it against the earnings outlook will give you a gauge of whether the dividend is safe from a possible cut.
Dividend Record Date
This is the date which the company will look at all shareholders to determine who actually gets a dividend. If you aren’t a shareholder on record at this date, you will not receive dividends whether you made a purchase of the stock yet or not.
The ex-date is basically when the seller of stocks will be entitled to the dividend even if he/she were to sell it on that day. Since the settlement date (the day it takes the records to be made) is 3 business days, the ex-date is usually 2 days before the record date.
In order words, if you buy the stock before the ex-date, you will be entitled for the dividend. If you buy it on the ex-date, you will not.
Dividend Declaration Date
The dividend declaration date is when the company announces the amount of the dividend, the ex-date, and the payment date.
Dividend Payment Date
The date that the dividend will be paid by the corporation.
Dividend Reinvestment Programs (DRIP)
In general, dividends will be paid to you (via check or in the modern days, automatically credited to your brokerage account) but there’s a way to reinvest dividends back into the company via dividend reinvestment plans. Quite simply, enrolling in a DRIP basically tells your brokerage to buy the stock whenever it recieves dividends instead of giivng you cash. The advantages are:
- Hassle Free Investing – This keeps your involvement out of it as it will automatically reinvest for you.
- No market timing – The program definitely keeps you invested and it takes timing the market out of the question. If the stock price is low, you will buy more shares. If the stock price is high, it will buy less shares.
- No fees – Most brokerages don’t charge you any commissions to reinvest the dividends, so while you are slowly accumulating shares, you aren’t paying commissions at all.
What Dividends Means for Us
Many argue that dividend stocks are the best way to invest in an up or down market because it helps cushion downturns and lets you accumulate more shares automatically in up market through DRIP.
It is no doubt that dividends are great if it’s secure. Just be careful that you don’t get caught up with a stock that is cutting or will eliminate its dividend as it will put a serious dent in its share price.
Other Thoughts on What is a Dividend
You hear about dividend payments all the time when discussing investments, and in general it is a good thing to make this kind of income. Depending upon where you are in your investment cycle you may opt to take the payment in cash or to reinvest it in the fund in question. Still, you may not know what a dividend actually is.
A dividend is a percentage of a company or fund’s earnings that is distributed to those holding shares. The board of directors determines what amount of the earnings will be distributed as dividend, and that sum is divided by the number of shares. However, those with preferred stock may have guaranteed dividends while those with standard stock may or may not earn any dividends during a given period.
Dividends are offered in order to increase interest in a company or fund, and they offer shareholders an opportunity to profit by the growth of the company. Companies which are growing rapidly may not offer dividends for a while, instead, reinvesting profits to help the company continue its expansion. Well established companies are most likely to offer higher dividends.
Dividends are not always paid in cash. Some are paid in additional stock or as property. While well established companies are most likely to offer such payments it is in part because the price of their stock is not as likely to move much. Therefore, while dividends may be a nice thing to receive they are also an indication of an investment that may not grow much from year to year.