I spend a lot of time on this site looking at lots of different dividend stocks that might make good investment opportunities. It recently occurred to me that I have never taken the time to explain what a dividend is and why they matter at all. So today, let’s find an answer to that question.
What is a dividend?
A dividend is simply a payout from a company that is paid out to its shareholders. Dividends are distributed in two forms. The first and most popular form of dividend payment is a cash payment. This is where a company issues a cash distribution to its shareholders. The payment can either be received via check or reinvested in order to buy more shares.
The second type of dividend that a company issues is a stock dividend. This dividend is issued in the form of additional stock so that it increases the number of shares that a shareowner has. A stock dividend does not increase the ownership percentage in a company since it is paid out to all shareholders.
When is a dividend paid?
Most companies pay dividends on a quarterly basis but that is not always the case. Dividends can be paid on a monthly, semiannual or annual basis as well. It all depends on the dividend policy of the company. Some companies pay special one time dividends when they want to give cash back to shareholders. Microsoft did this a few years ago to reward its shareholders.
What is the best way to get a dividend?
Common stocks are the primary way that most investors get dividends. Common stocks like Proctor & Gamble (PG) and Kraft (KFT) are example of good dividend stocks. Preferred stocks are an even better way for investors interested in consistent dividend income. Preferred stocks have a priority over common stocks when it comes to receiving dividends.
What are dividend stocks?
Good dividend stocks are companies that generate consistent cash flows and pay this cash out to investors in the form of dividends. They have a track record of paying dividends and offering dividend increases. The dividend yield should be attractive as well. Just because a company pays a dividend does not mean that it pays a dividend.
For example, Oracle (ORCL) and Hewlett Packard (HPQ) both pay a dividend to shareholders. They would not however be good dividend stocks because their dividend payouts are incredibly low at 24 cents and 32 cents respectively. They have incredibly low yields and do not have a history of raising their dividends. The payout ratios for both companies are 13% and 8% which shows that giving cash back to shareholders is not a priority.
Why is dividend income important?
There are only two ways that an investor can make money stock investing. They can either sell their shares or they can earn some cash via distributions. Dividend income is the only real form of profit that an investor gets before selling their shares. Paper profits can quickly disappear whereas dividend income comes in the form of cold hard cash. An investor can make some money through dividends and still maintain their investment position at the same time.
If you buy a lot of shares of a stock, dividend income can quickly add up. For example, let’s say you bought 1000 shares of Duke Energy (DUK). The stock currently sells for $18.97 and pays an annual dividend of 98 cents per share. A 1000 share investment would cost yield an investor a $245 cash payout every 3 month. That is a $980 payout per annum.
If an investor chose to reinvest their shares at the current price , they could add about 13.61 shares the first quarter, 13.79 share the 2nd quarter, and 14 shares in the 3rd quarter. As you can see the more that dividend income is reinvested, the larger the position that an investor is able to control.
Well, I hope that explains the basics of dividend investing and why it is an important part of an investor’s portfolio.