How Dividend Stocks Put Extra Cash in Your Pocket
Some companies pay their investors a share of their profits. These are known as dividend stocks.
If you’re the lucky owner of a dividend stock, you’ll be paid quarterly cash to do with as you please.
It’s easy to get excited about earning extra money from your investments, but there are a few things to know first. Let’s dive into the 411 of dividend investing.
What Are Dividend Stocks?
Dividend stocks are small pieces of a company you can purchase to become a partial owner in a (hopefully) profitable business. But these aren’t just any old stocks. They pay out part of the company’s earnings to shareholders (like you).
A dividend is the money a company distributes to its shareholders in regular payouts. The money is distributed from the company’s profits. Typically, you’ll receive dividend payouts every quarter.
However, not all stocks offer regular profit payouts. Before you invest, check to see if the stock you’re eyeing is a dividend stock. A good place to start looking is the Dividend Aristocrats list. This group of companies are tried-and-true dividend payers.
Where Do Dividends Come From?
With dividend-paying stocks, you’ll most often be paid from profits and positive cash flow.
Company payouts may also come from “retained earnings.”
These are overflows of cash that have accumulated or rolled over from a previous year and haven’t been used for anything else.
It pays to invest in rockstar companies. When they’re rolling in the dough, you may be too. That is if they’re willing to share.
Beware of companies that payout of their main capital. Profits are likely dried up, and they may be sinking like the Titanic.
Who Receives Dividends?
Investors who own stock in profitable dividend-paying companies are eligible to receive dividend payouts on a regular basis.
That’s right — average “Joes” like you and me can fund our Starbucks habits (or more wisely, our emergency funds) with this quarterly dividend cash.
It’s like being in Oprah’s audience four times a year! “Y-o-u get a car.”
Company Dividend Policy
The game plan for how a corporation uses its profits comes from a policy drawn up by the almighty board of directors.
These folks have a lot of important things to decide, not the least of which is whether to share profits with investors.
Not only do they have the final say in whether to pay dividends, but they decide on the amount, payout method, and timeframe as well.
Dividend policy types
- Stable dividend policy: Low and steady wins the race. It’s the most common, often a lower payment than other types, but offers a specified minimum amount on a regular payment schedule.
- Residual dividend policy: You get the leftovers. For the laid-back investor who doesn’t mind getting what’s left after the company spends the profits.
- Hybrid dividend policy: The best of both worlds. These payouts are mostly low and steady, but they’ll throw you a juicy bone when profits are good.This is a supplemental dividend (like a work bonus).
- Constant dividend policy: The “all bets are off” policy for risk-takers. Investors in companies with this policy have to be okay with just about anything. When profits are up, you may see a higher dividend. When they’re down, too bad — so sad.
How Are Dividends Disbursed?
Dividends usually come in the form of quarterly checks similar to your work paychecks.
How dividends are disbursed (and when) is determined by the company’s policy, and there are a handful of possibilities.
Dividend payment schedules
- Quarterly dividends are paid out every three months and are the most common payment schedule.
- Annual dividends are distributed once per year.
- Monthly dividend stocks pay out once per month.
- Semi-annual payments are made twice a year.
Types of Dividends
Although cash payouts are the most common, there are a few other types of dividends as well. Companies will usually stick with one of these methods:
- Cash payments
- Extra shares of stock
- Non-cash assets (these might be a company’s actual products)
How Much Will a Dividend Pay Out?
Let’s look at some examples of what you might earn with a dividend payout.
Keep in mind that the exact amount the company pays per share is determined by its board of directors. Your cut will depend on how many of the company’s stocks you own.
Here’s the math breakdown of a sample dividend payout.
Say a company chooses to pay a dividend of $0.50 per share and you own 500 shares. You would receive $250 from that particular dividend.
Dividend dates you need to know
The following dates will help determine the deadlines for when — and if — you’ll be paid when a company is divvying out profits to their shareholders.
Declaration date: The day that a board of directors announces there will be a dividend payment coming.
Date of record: The date a company checks its records to see who its shareholders are. You’d better be on that list if you expect a payment.
Ex-dividend date: Usually one business day before the date of record. You must purchase the company stock BEFORE this date or you won’t be listed as an investor on the date of record.
In short, any company stock purchased on or after an ex-date isn’t eligible for the upcoming dividend payment but must wait for future payouts.
Payment date: Exactly what it sounds like. This is the date set for paying the shareholders their piece of the profits.
How Do Dividends Affect the Stock Price?
When a company announces its intention to issue a dividend — as well as disclosing the amount of the payout — a pretty obvious thing happens to its stock value.
Investors, desperate not to miss out, are eager to buy shares of that stock. This temporarily drives up the share price as people scramble to buy before it’s too late.
On the ex-date, in a perfect display of sour grapes, investors who missed out on the dividend payment refuse to pay the hyped-up price, which then drives it down a bit.
Pros and Cons of Dividend Stocks
Owning a stock that pays you extra money sounds like a dream come true, doesn’t it?
Padding your emergency fund with those quarterly bonus payments is definitely a benefit of dividend stock ownership. The occasional splurge on your video gaming addiction never hurt anyone, either.
- Dividend-paying stock can provide a steady stream of income — it’s not guaranteed, though.
- Dividends are like a positive report card on the health of a company, so you can be a confident investor.
- They can stabilize your portfolio and minimize your risks of losing money when there’s a downturn in the stock market.
- Investment in stable and profitable companies means you’ll likely see dividend growth.
There can be some dividend downsides also.
- Dividend stocks aren’t without risk.
- Dividend payouts can be raised, lowered, or taken away at the drop of a hat — and without notice.
- A company might be forced to reduce or even eliminate client payouts if earnings suddenly fall or cash flow dries up.
What to Look For in Dividend Stocks
Investing in dividend-paying stocks is a smart move. A piece of advice: Evaluate the health of a company before you buy any shares.
What dividend investors should look for:
- A company that’s been around for a long time and has passed its start-up growth phase is a good investment.
- On the other hand, a corporation that’s fast-growing will need to reinvest most or all profits. Dividends will be unpredictable at best.
- Look for dependable corporate earnings. You’ll want a stable company that turns large profits year after year.
- Businesses that deal in essential goods (healthcare, food products, and utilities) can be strong candidates for dependable dividend payouts.
- When researching, make sure a company isn’t paying dividends without earning steady yearly profits.
Understanding Dividend Yield
Evaluating a company’s dividend yield is part of gauging the health of a potential investment and what your ROI (return on investment) might be.
Take the company’s annual dividend payout per share and divide it by the current price of one share of stock. This shows you what your potential earnings are for each share.
Bigger isn’t always better.
- Aim for a yield of around 2% to 4% to keep investment risk to a minimum.
- A modest dividend yield indicates steady growth and dependable payments.
- Companies with a high dividend yield of 10% or more should raise red flags. This could indicate rapidly falling stock values.
- High dividend stocks come with more risk. Companies can rarely sustain high payouts.
How Do You Start Investing in Dividend Stocks?
But first, you may want to come up with a plan that includes what your investing goals are and how much you have to spend.
Here are some guidelines to get you started, but expert financial advice is highly recommended before shelling out hard-earned cash.
- Determine whether you prefer high or low-risk investments (this can depend on your age and when you’ll need the money most).
- Open an account. Most good online brokerages are easy to navigate, have low fees, and offer plenty of educational materials.
- Carefully research companies you’d like to invest in.
- Large companies with plenty of financial stability are safest and most likely to pay regular dividends.
- You can learn about a particular company’s dividends by examining a stock’s quote.
- Once you’ve determined which stocks you’d like to buy, purchase the desired amount of shares through your brokerage account.
- Congratulate yourself on becoming a dividend investor.
Here are the most frequently asked questions about investing in dividend stocks.
Why should you consider investing in dividend stocks?
Anyone who’d like to bring in some passive income might want to consider adding dividend stocks to their portfolio.
While the payouts may not be huge, these stocks can be a smart addition to your diversified investment plan (as long as you’ve done your homework).
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How can you find out which stocks pay dividends?
Many brokerage firms offer information about stocks that pay dividends. They may even offer a list of recommended companies or the best dividend stocks.
You can also visit websites with a sole focus on dividend investing. A Google search will turn up several.
How much do you need to invest in a stock to get dividends?
Payouts are based on the number of shares you own. If you bought one share, you’ll get a tiny dividend.
This question is best answered by saying that there are some stocks that require a minimum purchase to own them in the first place.
As long as you own the stock, regardless of how many shares you bought, you’ll be paid dividends on each share.
The Bottom Line
After reading this article, I hope you’ll consider the benefits of investing in stocks that offer regular payouts.
Just think, buying a handful of quality shares can add diversity to your investments and put a little extra cash in your pocket to boot.