As an investor, you buy stocks to generate investment returns. These returns can come in primarily two different ways:
a) Capital gains, when the price of the stock in the market rises to a level higher than the price you paid when you purchased the stock. Capital gains are realized when you sell the stock at the higher price. and,
b) Dividends, that provide you an income without you having to sell the stock
In this short guide, we will talk about things you need to know when buying stocks for dividends.
What are Dividends?
Of the 5800+ stocks currently available to purchase on the major U.S. indices circa 2800 companies currently offer a dividend payout.
A dividend is an offer from the company to payout a portion of its income (after tax profits) to its shareholders. These companies tend to be well established with a stable income stream enabling them to offer a constant dividend. The dividend is essentially a reward to the shareholder for holding the stock.
Types of Dividend
- Regular Cash dividend, the most common type of dividend payment, usually released quarterly.
- Extra dividend, a special dividend usually a large one off payment to shareholders.
- Liquidating dividends usually paid if there are any left-over or allocated funds during the company’s liquidation.
The dividend payment is usually expressed in dollars per share. This means if I own 100 shares of a company whose stock price is $200, if the company pays out $5 per share then I will receive 100 X $5 = a $500 payment. Usually this is distributed on a quarterly basis, meaning I will receive $125 per quarter. Dividend Payment = Number of Shares X Payment per Share
Here is an example of the dividend yield. I own 1000 shares of ABC Company at a cost of $10 per share. ABC pays out a regular dividend of $0.50 per share. As a single share of the company is worth $10, $0.50 equates to a dividend yield of 5%.
Dividend Yield = Annual Dividend Paid / Stock Price
This 5% is essentially what you earn on your money regardless of stock price growth. Of course if the stock price deteriorates during the period in which you hold the stock this may mean your net profit reduces. For example, your make a 5% profit in terms of dividend yield, yet the stock price has depreciated 5%. This means your net profit if you were to sell would be Zero.
Dividend Payout Ratio
This is the proportion of the Earnings per Share (What is EPS?) that is paid out in dividends. For example if a company earns $2.50 in earning for every outstanding share, and it pays out $0.50 per share in dividends, then the dividend payout ratio is 20%.
Dividend Payout Ratio = Dividends per Share / Earnings per Share
This is the date 2 business days prior to when the dividend payment is scheduled.
For example if you purchase a stock on April 24th and the company announces the dividend payment date is April 30th, then you will be entitled to the dividend. However if you purchased the stock on the 29th of April, then the previous owner of the stock will receive the dividend.
Remember that normally the stock price will adjust for the dividend per share amount on the ex-dividend date. So if the dividend per share is $0.25/share, you can expect the stock price on the ex-dividend date to trade at $0.25/share less than what it otherwise would. On the date the dividend is paid, you will get the $0.25/share in cash as dividends, so there is no net change in the value of your holding due to the dividend payout.
When Buying Stocks for Dividends, what kind of Dividend Payouts Can You Expect?
Of the 5000+ stocks currently on the major U.S. Indices approximately 50% of the companies pay out a dividend. Here are some interesting facts. There are 2800 companies paying a dividend. Less than 0.5% pay-out a dividend of more that 10%. 25% of the companies pay out a dividend yield of between 5% and 10%. Less than 1% of companies pay a dividend of less than 1%. This means approximately 74% of the companies pay between 1% and 5%. A reasonable expectation is that you should receive a dividend of around 5%. Dividends can be a great way to generate a steady income from stocks, but beware, if a stock price is rapidly falling and the company is in trouble your net profit may not be as high as you expect. It is worthwhile to look for stock picks that not only pay dividends, but are also cheaply valued, as the risk of loss is significantly reduced.
Barry D. Moore is a Certified Stock Market Analyst (IFTA), Founder of LiberatedStockTrader.com and has been featured in Technical Analysis of Stock & Commodities Magazine. Try a Free 10 Module Stock Market Training Course