Investors widely love dividend stocks because dividends mean increased profits, reduced portfolio risk, tax advantages, and an additional metric for value investors practicing fundamental analysis. This article will take you through the basics of stock dividends.
What are dividends? Dividends are a reward for owning a share of a company. Most dividends are paid quarterly and provide the shareholder with their fair share of company earnings, usually paid directly from a company’s free cash flow. When investing in a company that pays a high dividend, you primarily pay for free cash flow and established ongoing business. Companies in the maturity or a declining growth cycle often pay out an attractive dividend to keep investors excited about their business, as growth usually declines.
In contrast to dividend-paying companies, high-growth companies’ stock prices are often driven by speculation and high expectation of growth. Value investors often refer to this phenomenon: The cost of a high-growth company is based on future cash flow.
What happens when dividends are paid? When a dividend is paid, several things happen regarding the concerning security. First, price changes in securities occur as the stock price is adjusted downward on the ex-dividend date. In addition, dividends are paid to accommodate the company’s market cap because paid dividends no longer belong to the company.
Dividends can cause further implications for companies. By retaining earnings, companies cannot invest capital into growth, forcing the company to manage the stock decline by good business performance and prospects.
In addition, dividends cause massive losses due to heavy tax burdens. This is because dividends are subject to double taxation, meaning that companies pay corporate tax to distribute funds effectively, and investors pay income tax on received dividend income.
What does long-term dividend investment look like? When investing for the long term, you might look at exchange-traded funds (ETFs), which can be summarized as a basket of companies or an accumulation of shares. These ETFs often contain dividend-paying companies, Annual dividends from these funds are either reinvested into your position (accumulating) or paid out to your account directly (distributing).
For investors interested in individual securities with a track record of dividend pay-out, DRIP might be an exciting strategy to grow their dividend income steadily. DRIP refers to the reinvestment of dividends every time they are received in new dividend-paying stocks.
To guarantee good dividend yields, investors look for dividend aristocrats. Dividend aristocrats are companies within the S&P500 that pay dividends consistently and have been raising dividends for 25 years.
How to get started with dividend investing Find out what determines a good value company for you as an investor. Every company is different, and there is something to say about investing in both growth and dividend stocks. We recommend every individual who wants to know more about dividend investing read the following books.
– The Intelligent Investor by Benjamin Graham
– Dividends Still Don’t Lie by Kelley Wright
– Active Value Investing by Vitaliy Katsenelson