Dividend Investing: An Introductory Guide

Dividends have historically produced more than half of all stock market returns in the last 110 years, even with rapid historical price appreciation, or capital gains.

For a long time, dividends were all but forgotten, due to hyper stock market price appreciation in the 80’s and 90’s. With the stock market roller-coaster that has been the past 12 years, they’ve made a huge comeback in the world of investing.

If we are truly in a new era of investing, where 10-12% average annual price appreciation is a thing of the past, including dividends as a component of your overall investment strategy might be wise.

But dividend investing is not for return chasers who only look at a juicy dividend yield before pulling the trigger on buying a dividend stock. So lets first get familiar with the basics.

What is a Dividend?

When a company makes profit, it has a few choices on what to do with that profit:

  1. It can retain the profit to re-invest it in the business.
  2. It can sit on its cash and keep it on hand for a rainy day.
  3. It can re-purchase its own shares (ideally raising the value of the remaining shares).
  4. It can pay out cash or additional shares to shareholders.

A dividend is the latter. Dividends are corporate profits that are paid out to shareholders of that company in the form of additional shares or cash (in the form of a check or re-invested shares, as determined by the shareholder).

Once a dividend is paid out, it is yours to keep or to re-invest. Dividends have a special allure for this reason, and particularly in times with high market volatility.

intro to dividend investing

How Often Do Companies Pay Out Dividends?

It is most common for companies to pay out dividends each fiscal quarter. Some companies pay out dividends semi-annually or annually.

Others (mostly REIT’s), have started paying out dividends monthly to appease retirees who rely on dividends for retirement income.

And finally, there are companies that will offer up special dividend payments to reward long-time shareholders, with no set schedule.

If you want to know how often a company pays out dividends, it is usually labeled on historical price charts for that company (i.e. Wal Mart, WM, on Google Finance below):

Each dividend payout is labeled with a “D” and the amount of the dividend payout is labeled above it. This allows you to see:

  1. How often does that company pay out a dividend. In the above example, you can see Wal-Mart has a quarterly dividend.
  2. How much is each dividend. In the above example, it ranges from $0.30 to $0.40 per quarter.
  3. If there were any lapses or declines in the dividend.
  4. The overall growth or decline trajectory of that companies dividend payouts.

Note that you’ll typically need to look at a 5 or 10-year chart for this information to populate.

Dividend Terminology Guide

There are a few different pieces of dividend terminology that you’ll want to know:

Dividend Yield: A dividend yield is the total annual dividend paid out, per share, divided by the share price of that stock. For example, if ABC inc. has 4 quarterly dividends of $0.50 each for a total annual dividend of $2, and its stock price is currently at $100, then it has a dividend yield of $2/$100 = 2%.

You will find dividend yield listed in any stock ticker portal.

In-Dividend Date: The date at which any existing holders of the stock and anyone who buys it on this day will receive the next dividend payment. This date coincides with the date of record, which comes a three business days after, and the ex-dividend date, which comes one day after.

Ex-Dividend Date: The date at and after which all shares bought and sold no longer come attached with the right to be paid the next dividend. In other words, you must own the stock at least 1 day prior to the ex-dividend date (aka the in-dividend date) in order to receive a dividend payout. It is the second business day before the date of record.

Declaration Date: The date on which the board of directors announces to shareholders and the market as a whole that the company will pay a dividend.

Dividend Payment Date: The date your dividend check is in the mail or you re-invest your payout into more shares.

A Note on Dividend Payout Arbitrage and In-Dividend and Ex-Dividend Dates

At one point I used to think that you could buy a stock prior to a huge special payout in order to receive the dividend and then sell it at a later date. There is no arbitrage opportunity here, as it may seem. Why?

The price of a stock is adjusted downward by the amount of the dividend on the ex-dividend date because the payout is subtracted from the stock’s market cap.

You can’t, for example, buy a stock with a huge 10% special dividend, in-dividend, in the hopes of being able to sell it, ex-dividend, after pocketing your 10% dividend.

Sorry to be a rain on your parade if you had this brilliant idea as I once did.

Taxes on Dividends: Ordinary Vs. Qualified Dividends

All dividends are considered “ordinary” dividends (meaning you pay at your ordinary tax rate), unless they are “qualified”. If your dividends are qualified, that tax rate is a special preferred rate of either 0% or 15%. Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 0% rate.

In order to be qualified, you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date and ends 60 days after.

There are special rules on preferred stock dividends that you can find more about in IRS Publication 550.

Sound complicated? It’s not really. You should be able to work it out fairly easily in your tax software program.

Note that qualified dividends were a Bush-era tax cut that is set to expire at the end of 2012. If not extended, all dividend income will be taxed at your ordinary tax rate.

How Can you Buy Dividend Stocks?

Dividend stocks can be purchased from any discount online broker, just like any other stock.

Dividends can also be purchased through a program called a DRIP (dividend reinvestment plan), where all dividends go directly back into the purchase of more shares, some times at a discounted price. Not all companies offer DRIP’s.

There are also a number of funds and dividend ETF’s that invest in dividend stocks as well. In upcoming posts, I’ll detail a few different dividend investing options.

Dividend Investing Discussion:

  • Are you using a dividend investment strategy?
  • What do you like/dislike about dividend stocks?
  • What dividend investments do you hold?

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