If you’re an investor looking for a regular income from your activities in the stock market, you will likely have come across the concept of a dividend. Dividends are payments that companies make to their shareholders. Dividends are an essential part of modern-day stock investing and so require detailed analysis to be fully understood.
In this article, we will discuss this key concept and expand upon the characteristics of Dividend Paying stocks. This will help you in grasping the fundamental tools behind dividend-paying stocks and better enable you to identify the right ones for your stock portfolios. We will also briefly touch upon certain high-dividend paying stocks which will pique your interest.
What exactly are Dividends?
At their core, dividends represent a portion of a company’s profits that are paid out to shareholders on a regular basis, typically quarterly.
Dividends constitute that part of the company’s wealth that is not reinvested into the business for developmental activities. For this reason, as we shall see in detail, later on, growth companies such as biotech and digital companies do not usually pay dividends.
This is because they reinvest most of their profits back into the business. How these dividends are paid can range from cash handouts to stock dividends, depending on the company and the type of stock. One thing to note here is that dividend payments also cause an increase or decrease in the share price by a proportionate amount.
The amount paid and the ex-dividend date is determined by the Board of Directors of the company. Investors who have shares in a company before the ex-dividend date are eligible for the dividend payments at specified dates. Those who invest afterward are not eligible and must wait for the next dates.
We can see clearly that dividends are like rewards handed out by a company to its shareholders in return for putting money into their ventures. For investors, these companies prove as a regular stream of income which helps them outpace inflationary pressures of the economy. For this reason, investors are very keen on investing mainly in companies that provide decent dividend payments.
Which companies provide Dividends
When it comes to dividends – and especially high-dividend paying stocks – an investor should not expect just any company to be able to give a high level of income. This is especially the case if an investor is looking into growth stocks of emerging biotech or internet-related companies.
This is because such companies mainly reinvest all their earnings into research and development. Shareholder dividends are not a priority for such smaller companies, so investors who have shares in these companies do so because of their optimism in the company’s future. For a well-established institution or industry, however, the case is different.
Let’s consider the example of an “old school” industry, that of automobiles. Car manufacturers can be much more likely to make regular dividend payments because they have already established themselves for many decades and do not need to invest as much into research and development, as a percentage of their revenues, as more emerging companies.
An automotive company can therefore focus its attention on dividend payments for shareholders. Massive companies with a history of well-reputed financial performance are quite regular in paying dividends to their shareholders. Other companies well-known for regular dividend payments are Johnson and Johnson, in the Consumer Staples sector, and Exxon Mobil, in the Energy sector.
Why do Companies pay Dividends?
We can easily evaluate from the observations that dividend payments are beneficial to investors in several ways. They provide a stable stream of income within the volatile world of the stock market. Additionally, since capital gains cash created through the sale of shares is considered taxable; investors looking for short-term gains may want to settle with tax-free dividend handouts. But a peculiar question arises: why would companies willingly hand out dividends when they can reinvest all their earnings into greater company development? Indeed, there are several reasons why a company may see dividend handouts as quite beneficial for its sustained development.
One major reason why companies may prioritize dividend payments is that they want to project a good image; when the price of a share goes up, it creates a sense of optimism and ease within the company management ranks. It also provides them with a greater incentive to grow and live up to the expectations created by the stock market.
Additionally, it also helps broaden the company’s brand and make it a subject of public attention. This would allow the company to garner greater investments which would aid in enlarging market share. They also help signal that the company has good cash-flow systems and is providing profitable avenues for investors.
All this makes them very attractive to investors looking at the stock market for a source of stable revenues. In short, dividend stocks and payments provide a mutually beneficial relationship between the shareholder and the company.
You may have heard of the concept of Dividend Yield, which is defined as the percentage of a stock price that is paid out in the form of dividends. For example, consider a stock that is valued at $50 per share. If the aggregate of its dividends in a given year is $1.50, the dividend yield is hence 3% (=$1.50/$50).
Why is Dividend Yield important? When considering the performance of a stock, or stock portfolio, most investors simply look at how much the price(s) of the stock(s) have (hopefully) increased over a period of time. While this price change will certainly be the dominant component of one’s investment growth over time, it is not the only one. This is where Dividend Yield comes in.
In the United States, the Dividend Yield in the S&P 500 Index, a benchmark for U.S. Large-Cap stocks, has typically hovered in the range of 2%. Since the beginning of 2008, the annualized total return of the S&P 500 Index is just over 10%, meaning that dividends contributed almost 20% of the total return of an investor who purchased an S&P 500 ETF. Twenty percent is clearly a non-trivial proportion of a portfolio return and emphasizes why Dividend Yield – and as we will see, investing in High-Dividend Growth stocks –should be a component of one’s portfolio.
Should you partake in Dividend Investing
We have observed the concept of dividend stocks and the type of companies that issue dividend stocks. We have also looked at the reasons why companies pay dividends to shareholders. The big question now is whether you should partake in dividend stock investing strategies.
In this section of the article, we will be looking at the risks and associated benefits of investing in dividend stocks, hopefully concluding with a solution as to whether you should invest in dividend stocks or not.
Risks of Dividend Stock Investing
While investing in high-dividend paying stocks may seem appealing to the eye, several associated risks are worth considering. Firstly, like dividend yield increases, it is a given that stock market prices can – and often do – go down. The reason for this is intuitive but can be left unexamined by novice investors.
One risk is that dividend stocks can be affected by macroeconomic trends and specific economic recessions. For instance, the 2008 Financial Crash led to several well-reputed companies that stopped issuing dividend payments while riding out the storm, even if those companies were not directly affected by the Crash.
Another risk that arises is that dividend payments are usually isolated from growth companies. This means that most of the companies that deliver dividends are well established and provide lower returns than exciting emerging companies. What this creates is a trade-off between stability and potential. The former guarantees some return, while the latter offers the promise of meaningful short-term profitability.
Benefits of Dividend Stock Investing
As we discussed earlier, dividend yield can be an important component of an investors’ long-term performance. Indeed, high dividend yields often symbolizes sound financial performance. What this means is that even if returns on capital are lower than expected, those returns are stable and destined to increase in the long run.
While we generally emphasize the importance of a long-term perspective when it comes to navigating the volatility associated with Equity investing, having some semblance of stability in a portfolio also has merit. Dividends check this stability item.
Dividend Stocks you should be looking into
As we have mentioned throughout this article, a key component of any company which issues dividend stocks is stability. Hence, the first indicator for investors is the historical performance and repute of a particular company. This repute has to be followed up by a well-established structure that allows the company to afford to pay shareholders on a regular basis. For this reason, up-and-coming companies in the technological or biotech sector don’t fare well when it comes to dividend-paying stocks.
Now, another dilemma that must be tackled when confronting the stocks to invest in is whether the investor should go for Exchange-Traded Funds (ETF) or individual stocks. There are distinct advantages and shortcomings for both, and so it depends on the needs of the individual investor which route they opt for.
Using ETFs ensures stock portfolio diversification and minimized risks. This is especially the case if the investor looks for ETFs that include companies within the dividend aristocrat list. This list includes companies from the S&P 500 that have stable and increasing yields and revenues.
By utilizing the ETFs consisting of high-dividend paying companies, investors can gain access to the benefits of high-dividend yield without having to play the individual stock picking game, the latter of which has been shown to have poor outcomes in the long run. As noted in a previous blog entry, ETFs are also very inexpensive (low expense ratios) and are highly tax-efficient.
In this article, we looked at the many different facets of high-dividend paying stocks. Through the analysis of its risks, benefits, and needs within the world of modern finance, we can come to the conclusion that such stocks are an essentially beneficial component for investors.
Most investors eligible for such dividend payments are high-profile figures who have prior experience in the stock market. This lowers the possibility of venturing into risky projects while also providing a steady source of comfort to investors navigating through the stock market.
September 13, 2021