Tuesday, May 10, 2016

Investment Essentials: Dividends

Income stocks are the bread and butter of any defensive investor's portfolio. When I talk about income stocks, I of course point towards dividend paying stocks. If you don't know what dividends are however, you may be a little confused.

Dividends are payments that are made to investors on behalf of the company they invest in. These payments are paid to the investor without the investor having to actually sell any part of their shares. By collecting these dividends, your portfolio can grow without having to worry about making capital gains. It can make gains just by the dividend payments that are issued.

If you are unsure if a company issues dividends, pull them up on Yahoo Finance or any other place that lists a stock's information (TDAmeritrade, Google, etc) and look for a field that says yield. Yield is interchangeable with dividend payment and it is usually listed as a percentage but can be followed by the actual breakdown of the payment in relation to the current price. A company however is not forced to continue these payments if you buy into them while they issue them. They can discontinue them at any time given that the board advises to discontinue them.

This is why it is important also to check a payment ratio. This ratio is the breakdown of how much the company pays out in relation to their profits. The easiest way to calculate the payout ratio is to dividend the dividends paid per share by the EPS (earnings per share). Generally, a good rule for longevity is to invest in companies that have a payout ratio of less than 60%. This would seem to suggest that they have a lot of room if profits dip a little in order to still issue dividends each quarter, month, or year.

That's dividends in a nut shell. The only other thing I would wish to point out would be that these payments are made only to investors who are owners of shares before the ex-dividend date. Keep this in mind when you invest in dividend paying stocks as you may miss a payment if you don't get in before that date. Of course, even this can be a double edged sword as once the ex-dividend date passes, the price per share will decrease by the amount of the dividend paid. If you hold for the long term however, you need not worry about this little hiccup.

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