You might have heard the term “Dividend Payments” or “Dividend Stocks” and wonder how these terms relate to investing and why they are essential to an individual investment portfolio. To understand the advantage of dividend stocks, investors must first learn what dividends are.
Dividends are payments a company’s board of directors agreed to pay to the shareholders of that company’s stock. It can be seen as the companies sharing their profits with their shareholders. A company that pay dividends also can be considered a positive from an investor's viewpoint and a reward. There are various reasons why the board approves dividend payments, but they are not guaranteed.
Not all stocks pay a dividend, so an investor must research and specifically choose which dividend stocks is best for their investment portfolio. It is best practice to work with a financial advisor when looking to invest.
How Do Dividend Payments Work?
Dividends are paid on a per-share basis. Payments are usually paid quarterly, but a company can pay out dividends as often as the board pleases. Let’s look at how a dividend payout work. An investor owns 100 common stock shares of ABC company. ABC Company's board of directors has agreed to pay $3 in annual cash dividends. The investor will receive $300 that year in dividend payments. Usually, the payment will be divided into four payments of $75 per quarter.
100 Stock Shares x $3.00 = $300 / 4 = $75
Once the board of directors approves the dividend payment, the company must announce when the dividend is scheduled to be paid, the amount paid, and the date that an investor must own the stock, better known as the record date.
The record date is how the board of directors determines the shareholders that are entitled to receive the dividend. For example, ABC Company decided on April 1 to payout a $2 dividend payable on May 3 to shareholders of record on April 15. Anyone on ABC Company records as a shareholder on April 15 will receive the $2 per-share dividend on May 3.
Type of Dividend Payouts
Cash Dividends are the most common pay-out option. Cash is paid to the investor brokerage account in which the investor can choose to do what they want with the money. Note: Depending on the decision, there may be tax responsibilities.
Stock Dividends are paid in the form of stock instead of cash. For example, ABC company decides to issue a 3% stock dividend. The investors own 300 common stock shares of ABC company. The investor will receive an additional 9 shares ($300 x 3% = 9 shares) of ABC stock.
Preferred Dividends are paid to investors who own preferred stock. Unlike common stock dividends, preferred dividends are fixed, and this is because preferred stock functions less like a stock and more like a bond.
Special Dividend is a one-time payout that is not scheduled as a regular dividend. For example, ABC Company will pay out a special dividend due to more than expected profits and now have an surplus of cash on hand. Special dividends shouldn’t be expected as something that is to happen frequently.
Benefits of Purchasing Dividend Stocks
Companies that have been around for years that are established, reliable, and show innovation with the times are most likely to pay dividends for decades and continue to raise their dividend payments. Dividend payments by a company can be an indicator to the investors that the company's financials are in good health. Don’t get this confused with High Growth companies such as techs companies that rarely pay dividends. High Growth companies usually will use profits to reinvest into the growth of the company.
Doing market downturns, even if the stock has a negative quarter, for example, the company still can pay dividends. As the investor, this is a benefit because you are continuing to receive a type of income stream for owing the stock during a down market.
The most significant benefit of dividend payments is participating in a Dividend Reinvestment Plan (DRIP). The DRIP plan is when an investor receives a cash dividend, and the dividend is automatically reinvested to purchase more of the same stock.
DRIP gives the investors the ability to purchase fractional shares. For example, ABC company pays you an annual dividend of $2 per share ($0.50 per quarter) on a stock that trades at $38 per share. You own 500 shares of ABC company stock. Because of the DRIP plan, when the quarterly dividend is paid, you will receive cash dividend payout of $250 ($0.50 x 500 shares = $250). The $250 cash dividend will be reinvested to purchase 6.58 additional shares ($250 / $38 = 6.58 shares ). Now you own 506.58 shares (500 shares + 6.58 shares = 506.58 shares) of ABC stock.
Next quarter, you will recieved a cash dividend payout based on 506.58 shares which equals to a cash dividend payout of $253.29 ($0.50 x 506.58 = $253.29). The $253.29 is reinvested to purchase 6.67 additional shares ($253.29 / $38 = 6.67 shares). The total shares you own after the reinevesment is 513.25 shares (506.58 + 6.67 shares = 513.25 shares).
As mentioned, dividend payments are not guaranteed. But if you are participating in a Dividend Reinvestment Plan and the company's board of directors continue to approved the payment of the dividend, the increase of shares will continue as such for each quarter.
Example of Companies That Pay Stock Dividends
Investors can also purchase dividend mutual funds and exchange-traded funds (ETFs) if purchasing individual stocks is too expensive or exposes their portfolio to too much risk. These funds hold various dividend stocks in one package and will payout schedule dividends from those holdings.
Stock dividend payments are essential to one’s portfolio. It allows the investor to receive income from owning stocks and gives the investor the ability to reinvest the dividend income automatically through the Dividend Reinvestment Plan. The combination helps the investor portfolio grow, receive a steady income, and protect against inflation while purchasing and earning more company shares. As an investor shares increase, dividend payments increase also.
Due to the nature of investments and individual stocks, it is best to talk to a financial advisor to determine if dividend stocks can benefit your investment portfolio.
Disclosure: The author held no financial position in the stock investments mentioned at the time of this original publication, nor is the author recommending purchasing of the stocks mention in this publication.
The information contained herein is intended for educational purposes only and is not exhaustive. Diversification or any strategy that may be discussed does not guarantee against investment losses but is intended to help manage risk and return. If applicable, historical discussions or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax, or financial advice. Please consult a legal, tax, or financial professional for information specific to your individual situation.
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