As an investor, there are essentially two ways in which you can earn a profit on stocks. First, by practicing the axiom of “buying low and selling high”. The second way of earning money, and the focus here, is by purchasing stocks that offer dividends.
The first dividend was made in the 1600s by the Dutch East India Company. dividends have been wildly successful among buy-and-hold investors ever since and they’re definitely worth getting to know better, if not master outright.
What is a dividend?
Dividends, both current and historical, is the focus of attention for many investors when they consider which investments to buy.
They represent the portion of a company’s profit that it pays to shareholders. Dividend income is a ‘passive income’ source, making it a foundational element of a long-term investment strategy. Dividends are typically paid out to shareholders quarterly with frequency often depending on the industry or sector of the public company. Dividends can vary from a few cents per share to tens of dollars per share.
When you receive a dividend payment as an investor, you can keep the money or decide to use it to purchase more stock in the company.
The size and frequency of dividend payments are decided by the company’s board of directors – but must be approved by shareholders.
A dividend cut – or worse, a stoppage of dividend payments – can be very bad news for all concerned. These indicate that a company may be in a weak financial position, perhaps as a result of growing debt or declining earnings, negatively impacting the stock price.
Should a company be unable to pay all dividends, a hierarchy exists of whom will receive payment. Creditors, that is bondholders, receive priority over shareholders. Within the shareholder category, preferred shareholders receive priority over common shareholders.
A huge range of dividend stockscan be found on stock markets around the world, in an array of sectors, including telecommunications, real estate (through real estate investment trusts, or REITs), healthcare, financial services, utilities, and consumer staples like packaged goods.
Why consider stocks that pay dividends?
In a nutshell: dividend-paying companies can provide a little more certainty than growth stocks. They tend to be less volatile, so dividend stocks can also help diversify one’s portfolio and reduce risk. That makes dividend investing a very popular investment strategy for more traditional investors or those who tend to buy-and-hold their securities.
Putting aside the possibility of a dividend cut (see above), dividend payments tend to be dependable, unlike a stock’s price. There’s also the matter of capital gains. It’s common for a dividend-paying stock’s capital gains to out-perform that of a stock that doesn’t pay a dividend.
If you’re looking for solid dividend-paying stocks for your portfolio, its obviously smart to know the company’s history of dividend payments. Go back a decade or more. Are their dividends payments steady or increasing year after year? Have they missed a dividend payment, or lowered the amount they pay out?
How do dividends work?
Why do some companies pay dividends while others don’t pay dividends?
A dividend is a distribution of a portion of a company’s retained earnings to shareholders. Dividends usually take the forms of cash payments or more stock shares. Your dividend payments are based on the number of shares you own.
Share prices and dividend payments are closely linked, and it’s smart for every investor to pay attention to the relationship between the two.
A case in point: if a share’s price increases, its dividend payout, which remains constant (at least for the time being), will represent a smaller proportion of your total investment.
Impressive dividend payouts don’t necessarily tell the entire story. Investing on the basis of high dividends alone can be a dangerous strategy. Consider this: a company with a dramatically increasing dividend yield may have seen its share price fall and be unable to sustain their dividend payments in the future.
A common question among novice investors: why don’t start-ups and companies in especially high-growth sectors, such as technology, offer dividends? These companies tend to reinvest their profits to continue fueling growth.
What’s dividend yield and how is it calculated?
Dividend yield, which is expressed as a percentage, refers to the expected return on investment (ROI) received from the annual dividend. over one year. It’s calculated by dividing the annual dividend by the current share price of the stock. Here’s an example:
One share of ABC trades at $100 per share, and it pays out $10 in annual dividends. Thus, its dividend yield, or the dividend ROI of one share of ABC, in this case is 10%.
The dividend yield will change constantly because it’s based on the current share price. For instance, if ABC’s stock rises to $110 per share, the dividend yield goes down to approximately 9%. The opposite is true too of course: a lower share price results in a higher yield. In this way, the two numbers move inversely to each other.
What are dividend payout ratios and how is it calculated?
Dividend payout ratios (DPR), expressed as a percentage, tells investors how much money a company is giving back to its shareholders and how much they intend to keep for their various corporate goals. The figure is based on the company’s net income.
For example, a company with a net income of $100 million that has paid its shareholders $15 million has a dividend payout ratio of 15%.
Ratios vary greatly and it’s not advisable to make any investment decisions based on the size of ratios alone. In fact, they can be downright misleading.
Why some companies pay dividends?
Essentially, they use dividends as a way to both attract and retain investors. By doing that, companies hope to boost overall growth of their stocks, thereby increasing their stock’s share price.
So why don’t all companies pay dividends? It depends on the growth trajectory of the individual company as it passes through the various company lifecycle stages. A very large company, in the ‘mature’ lifecycle stage, has fewer growth opportunities and may look to reward investors with dividend income instead of significant stock price appreciation.. Paying dividends to shareholders enables it to maintain their stock’s value. On the other hand, smaller companies in the growth stages, whose growth trajectory is steeper, probably doesn’t need to offer stock dividends to appeal to investors as it will likely generate higher growth-based returns from its stock appreciation.
What’s the difference between cash dividends and one-time dividends?
While cash dividends are by far the most common form of dividend payments, there are others. Let’s take a look at the main types:
Cash dividends are a payment to shareholders in cash, in the form of either a cheque or electronic payment. These payments are paid from the company’s retained earnings.
Stock dividends involves the issuance of common stock by a company to pay its common shareholders. The value of these shares is based on their fair market value at the time of issuance. By the way, whether a company pays its shareholders in stock or in cash has no impact on a company’s worth.
One-time dividends, also known as special dividends or extra dividends, are one-off dividend distributions to shareholders and are typically larger than the normal dividend payments. One-time dividends can be triggered by very strong earnings, or by the sale of the company’s subsidiary, among other notable events.
Other dividend types include property dividends, a form of non-monetary dividend which is based on company assets; scrip dividends, which almost work like promissory notes to pay shareholders in the future; and liquidating dividends, which are common when a business is closing.
When do dividends get paid out by corporations?
Paying dividends is serious business to a company and its directors. To ensure transparency, financial responsibility and optimal value to shareholders, a dividend process is utilized. We’ll highlight the most important dates below:
Dividend Process – 4 Key Dates
Declaration, or announcement, date
This is the specific day that a board of directors announces its intention to pay a dividend. There will have been weeks and even months of work before the announcement of the specific declaration date.
Date of record/Record date
The date on which the company identifies shareholders eligible to receive their dividends.
Ex-dividend date, or ex-date
If a stock sale hasn’t been completed by the ex-dividend date, then the seller of the stock on record – rather than the buyer – gets the dividend. For more, see “How long do you need to own the stock to get a dividend payout?” below.
Payment date/Date payable
The payment date is the date on which a company's dividend is paid to shareholders.
How long do you need to own a company’s stock to get a dividend payout?
Let’s take a closer look at the ex-dividend date, a date in the dividend process that some new dividend investors sometimes confuse with date of record.
As noted above, a company sets a record date when investors must be “on the books” as a shareholder to receive dividends. The ex-dividend date typically precedes the record date by two business days. If you buy stocks one day or more before the ex-dividend date, you’re eligible to receive the dividend.
If you buy a company’s stock on the ex-dividend date or after, however, you will receive the shares of the company ex[cept]-dividend. That is, buying shares of a company on the ex-dividend date leaves entitlement of the upcoming dividend payment in the hands of the seller.
How often are dividends paid?
The majority of shareholders will receive dividend payments four times a year on a quarterly basis. A minority of companies pay dividends monthly, semi-annually or annually.
Metrics to know for dividend/income investing
While dividend yield and payout ratio were discussed earlier, we wanted to include these metrics here as part of a more extensive list of metrics available to assess the viability of dividend stocks in your portfolio.
Yields show you the expected dividend amount you’ll be paid annually. For example, if you purchased $2,000 worth of a company’s stock with a 10% dividend yield, you can expect a total dividend payment of $200 over the course of the year, although this is not guaranteed.
This percentage tells you how much of a company’s earnings are set apart as dividends for shareholders. For instance, say a company earns $10.00 per share and pays an annual dividend of $5.00; it’s payout ratio is 50%.
Dividend growth is a look at a company’s dividend history. You’ll want to see if the company continually raises dividend payments (a good sign) or, on the other hand, misses dividend payments (a bad sign). The caveat, as expressed earlier, is that the past payments may not 100% predict future payments, but it’s a start for sure.
This metric measures a stock’s volatility in relation to a benchmark, such as the S&P/TSX Composite Index. A value of “1” means that the stock’s volatility is in line with the market. Less than “1” means the stock exhibits lower volatility relative to the market, and more than “1” suggests above-average volatility relative to the market.
Free cash flow
Investors who desire to drill down deeper into a company’s dividend stock will go beyond payout ratio. They want to know the company’s free cash flow. This metric helps to reveal the amount of cash that is flowing into a company from operations minus the cash that is flowing out for capital expenditures; , thereby offering a potential indication of a company’s ability to cover its dividend payments.
Companies take on debt for a host of reasons, such as to expand their operations or retire outstanding shares. The problem is, companies that carry especially heavy debt loads are more vulnerable should the economy go south. Cutting dividends may be one of their solutions to get back on track financially. To calculate debt-to equity, divide a company’s total liabilities by its shareholder equity. Both of these figures are easily found on company financial statements.
What’s a good debt-to-equity ratio? That depends a lot on the industry you’re researching, but generally 1 to 2 is considered an acceptable debt-to-equity ratio.
What is a Dividend Reinvestment Plan (DRIP) and a Dividend Purchase Plan (DDP)?
To determine if you’re eligible or to enroll in the DRIP/ DPP program, call us at 1-888-872-3388. Alternatively, you can log onto scotiaitrade.com, click on the “Contact” link at the top of the page and then select “Send Us a Secure Message.”
Please note, the DRIP/DPP program only reinvests in whole shares, so subsequent dividends paid out need to be sufficient to buy at least one whole share.
To be eligible for the plan, you must enroll up to two weeks prior to the dividend distribution date.
When a dividend-paying stock is enrolled in a DRIP or DPP, the dividends you receive are automatically used by your brokerage to buy additional shares of the same stocks. For dividends that are less than the value of one stock, this will be redeposited into the account which holds the stock. The compounding nature of DRIPs and DPPs make them ideal for long-term, income-focused investors.
What are the benefits of DRIPs and DPPs?
The process of reinvesting dividends is totally automated – you don’t have to monitor the process (unless you want to!)
Pay low commission fees – or no commission fees at all – for purchases initiated by the DRIP and DPP system.
Benefit from dollar-cost averaging – the strategy of investing identical amounts of money at regular intervals with the goal of reducing the impact of price volatility on the overall stock purchase.
Enrollment in DRIPs and DPPs is simple, easy and fast.
It should be noted that a potential drawback of dividend investing is that it may overweight your position. That is, a client’s portfolio may become less diversified and more sensitive to the risk of this one investment.
The bottom line: 5 reasons to consider dividend stocks
Dividend stocks can play an important role in many investment portfolios. As always, do your research and factor in your preferred level of investment decision, risk tolerance, dividend yield expectations, and so on.
Dividend yields are typically more stable than stock prices and earnings
Dividends are a good source of passive income, making them a worthy consideration for long-term investors with an income-focus.
Dividend-paying companies are historically more stable companies.
Dividend stocks give investors two ways to earn returns: through dividend payments and share price appreciation.
Plus, when you enroll your stocks or exchange traded funds in a DRIP or DPP with Scotia iTRADE, you can benefit from dollar-cost averaging and your stock purchases can be commission-free.