Dividend investing puts a focus on building a portfolio with high quality companies that are paying a regularly growing dividend. The focus is on the cash flow from the dividend rather than stock appreciation. The goal is to create passive income from which one can live off.
In times of dislocation in the markets, the cash flow from dividends can be reinvested in the markets at low prices, it can also act as a psychological stress reliever when you see your portfolio decrease in value.
What are dividends?
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders.Wikipedia
A cash dividend is the most common type of dividend, public companies usually pay dividends on a fixed schedule, but may declare a special dividend at any time.
The dividend yield is the ratio of the company’s share price that it pays out in dividends each year. A company with a stock price of $50 and an annual dividend of $2.00 will have a 4.0% dividend yield.
Dividends are usually taxed unless you hold your shares in an IRA account.
There are some important dates to remember regarding dividends. The most important ones are the “record date” and the “ex-dividend date“. When a company declares a dividend, it also sets a record date when you must be a shareholder to receive the dividend. The ex-dividend is usually one business day before the record date. You must purchase the shares before the ex-dividend date in order to receive the dividend that was announced.
Here’s an example:
|Declaration Date||Ex-Dividend Date||Record Date||Payable Date|
Dividends are not guaranteed, just because a company used to pay them in the past doesn’t mean it will in the future.
There are some metrics you would want to evaluate before investing: 🚨
- The dividend payout ratio:
- A company that pays out less than 50% of it’s earnings is considered stable.
- Are the earnings growing and does the company have a potential to increase the dividend?
- A high dividend yield:
- A high yield is usually caused by a depressed share price signaling that the market doesn’t believe the dividend payout is sustainable in it’s current form. There are no free gifts in the financial markets. Unless it’s a time of dislocation in the market I would be very carful in investing in companies with extremely high dividend yields (>6%).
- Dividend growth rate:
- Has this company been increasing its dividend in prior years?
- Have the company’s earnings grown above the dividend increases?
- Cash flow from operations: How much cash is the company generating. This cash will need to cover interest payments on debt, capital investment and the dividend. One warnings sign would be interest payments on debt the same size of the dividend payment.
- Debt to EBITDA (Earnings before interest depreciation and amortization) – The lower the better.
Companies that increase their dividends over long periods of time are often broken into categories:
- Achievers: companies that have increased their dividend every year over the past 10 years.
- Aristocrats: companies that have increased their dividend each year for at least 25 years.
- Kings: companies that have increased their dividend each year for at least 50 years.
Dividend Reinvestment Plan (DRIP)
DRIP is a program set by the company that allows its shareholder to reinvest their cash dividends into additional company shares. The program automatically uses the cash from the dividend (after tax) to purchase shares from the company.
Companies use DRIPS to sell small amounts of shares because it ultimately gives them low-cost access to more capital. When investors purchase a stock on an exchange, they’re essentially buying it from other investors, therefore the company sees no benefit from the sale. But with DRIPs, shares are bought directly from the company, which benefits from the proceeds reinvested under its own roof.investopedia
I hope you found this article useful, happy investing.
- Invesco Dividend Achievers list
- S&P 500 Dividend Aristocrats index
- S&P 500 Dividend Aristocrats list
- Dividend Kings list
Disclaimer: This article does not represent investment advice and is solely the author’s opinion. The author is not a financial advisor. Readers are expected to perform their own due diligence before making investment decisions.
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