When investing, you might come across companies that are known as ‘dividend payers’. What exactly does this mean and should you buy into them?
When you invest in certain companies, you will be given a share of the current earnings or profits of the firm. It is essentially a payment for being a shareholder. There are also other financial instruments that give you dividends, such as REITs and investment funds. Cash dividends are normally given to stockholders on a periodic basis, usually every quarter.
Some companies will issue dividends in the form of extra stock rather than cash. Investors can decide to keep the cash dividend and use it as they please, while others like to immediately reinvest these funds back into the company.
By investing in companies that issue regular dividends, you are realizing a return on your investment without having to sell any stock.
What is a dividend stock?
A dividend stock is an investment that will pay out a periodic dividend and will do so regularly, rather than it just being a one-off payment. You will have this dividend credited to your investment account or automatically reinvested if you have chosen this option.
As an example, a company may pay stockholders an annualized dividend of $0.20 per share. Usually, dividends will be paid out quarterly, so at the end of a business quarter, you will have your investment account credited with a cash dividend of $0.05 per share.
While these dividend sums may not seem to be very significant in the beginning, they can add up substantially over time as you build up a portfolio that contains hundreds and thousands of shares of dividend stocks. These funds can then be reinvested as you please.
There is usually a declaration date on which the board of directors of a company announces their plan to pay a dividend and outlines the date of payment. The date of record is the exact date on which the company looks at its records to see who the stockholders are eligible to receive the dividend.
There will normally be an ex-dividend date, which means that only those people who own the stock before this date will be eligible to receive a dividend for the most recent period.
Why do investors sometimes not want a dividend?
Many companies do not issue any dividends at all, preferring to reinvest profits back into the business rather than paying out to shareholders. This means that the company can focus on maximizing growth, oftentimes leading to your invested sum appreciating over time as the share price rises.
The level of capital appreciation you see can often outstrip the dividend yield and capital appreciation combined of a traditional dividend paying stock over the same period. Therefore, in this case, investors are profiting more from a company not paying out a dividend than receiving regular payouts.
What is a dividend yield?
Dividend yield is a percentage of the sum of money a company will pay a shareholder for every share that they hold divided by the current share price. As the price of a share falls and the size of the dividend stays the same, the dividend yield increases.
If the annual dividend of a company is $0.20 per share and the current share price is $10, the dividend yield is $0.20/$10 = 2%
A higher dividend yield, with everything else being equal, will usually be preferred. However, there are flaws that come with solely looking at dividend yields, as they can be distorted by a sharply falling share price.
What is a dividend reinvestment plan?
A dividend reinvestment plan is when you reinvest cash dividends back into the given company by buying more shares of the stock on the day of the dividend payment. You can often enact automatic reinvestment with the given company or investment fund.
In a lot of cases, you get discounts on the share price when doing so and you have the ability to buy fractional shares when you are enrolled into an automatic dividend reinvestment plan. Over the long run, reinvesting dividends will lead to the compounding of your returns.
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