What Are Dividends and The Advantages of Dividend Stocks?

You might have heard the terms "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 that a company's board of directors has 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 pays dividends can also 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 dividends, so an investor must research and choose which dividend-paying stocks are best for their investment portfolio. It is best practice to work with a financial advisor when investing.

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 works. An investor owns 100 shares of ABC Company's common stock. ABC Company's board of directors has agreed to pay $3 in annual cash dividends. The investor will receive $300 in dividend payments that year. Usually, the payment will be divided into four $75 payments per quarter.

100 Stock Shares x $3.00 = $300 / 4 = $75

Once the board of directors approves the dividend payment, the company must announce the dividend payment date, the amount paid, and the record date, which is the date by which an investor must own the stock to receive the dividend.

The record date is the date by which the board of directors determines which shareholders are entitled to receive the dividend. For example, ABC Company decided on April 1st to pay a $2 dividend, payable on May 3rd, to shareholders of record on April 15th. Anyone listed as a shareholder in the ABC Company records as of April 15th will receive the $ 2-per-share dividend on May 3rd.

Type of Dividend Payouts

Cash Dividends are the most common payout option. Cash is deposited into the investor's brokerage account, where the investor can choose how to use it. Note: Depending on the decision, there may be tax responsibilities.

Stock Dividends are paid in the form of additional shares of stock instead of cash. For example, ABC company decides to issue a 3% stock dividend. The investors own 300 shares of ABC's common stock. The investor will receive an additional 9 shares of ABC stock ($300 x 3% = $ 9).

Preferred Dividends are paid to investors who own preferred stock. Unlike common stock dividends, preferred dividends are fixed 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 a special dividend due to higher-than-expected profits and now has a cash surplus. Special dividends shouldn't be expected to happen frequently.

Benefits of Purchasing Dividend Stocks

Companies that have been around for years, are established and 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 indicate to investors that the company's financials are in good health. Don't confuse this with high-growth companies, such as tech companies, that rarely pay dividends. High-growth companies usually reinvest profits to fund growth.

During market downturns, even if a stock has a negative quarter, the company can still pay dividends. As an investor, this is a benefit because you continue to receive an income stream from owning the stock during a down market.

The most significant benefit of dividend payments is the ability to participate in a Dividend Reinvestment Plan (DRIP). The DRIP plan is when an investor receives a cash dividend and automatically reinvests it to purchase more of the same stock.

DRIP allows investors 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 a 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 of ABC stock (500 shares + 6.58 shares = 506.58 shares).

Next quarter, you will receive a cash dividend payout of $253.29 based on 506.58 shares ($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 reinvestment are 513.25 shares (506.58 + 6.67 = 513.25).

As mentioned, dividend payments are not guaranteed. But if you are participating in a Dividend Reinvestment Plan and the company's board of directors continues to approve dividend payments, the number of shares will increase each quarter.

Example of Companies That Pay Stock Dividends

• Suncor Energy

• Abbott Laboratories

• FedEx

• McDonald's

• Home Depot

• Coca-Cola

• Allstate

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 scheduled dividends from those holdings.

The Takeaway

Stock dividend payments are essential to one's portfolio. It allows the investor to receive income from owning stocks and automatically reinvest dividends through the Dividend Reinvestment Plan. The combination helps the investor's portfolio grow, receive a steady income, and protect against inflation while purchasing and earning more company shares. As an investor's shares increase, dividend payments also increase.

Given the nature of investments and individual stocks, it is best to consult a financial advisor to determine whether 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 the purchase of the stocks mentioned in this publication.

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Collins Wealth Management LLC is a Fee-only, fiduciary Registered Investment Advisory firm. The information herein is intended for educational purposes only and is not exhaustive. Diversification, or any strategy 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 situation.