What are Dividend Stocks?

March 29, 2022

Building Wealth through Dividend Stocks

Put simply, a dividend stock is considered to be a stock of a company that is known for regularly paying dividends. A dividend is a portion of a company’s profit distributed among shareholders. These companies are typically well-established in their industry and have more predictable earnings. Dividend investing is one of the ways that people use their investments to earn income. 

Types of Dividends

There are five kinds of dividends: cash dividends, stock dividends, dividend reinvestment programs, special dividends, and preferred dividends.

A cash dividend is what it sounds like – a shareholder payment in cash from a company’s earnings. On the other hand, shareholders receive additional stock with a stock dividend from the company. Cash dividends are usually paid out quarterly but could be released semi-annually or annually.

Dividend reinvestment programs, or DRIPs, allow investors to reinvest their dividends back into their stock. 

Special dividends are typically non-recurring and non-scheduled. A company might issue a special dividend if it has excess cash on the balance sheet and wants to reward shareholders instead of reinvesting capital into the business. 

As opposed to common stock, preferred stock is a type of stock that functions less like a stock and more like a bond. Preferred dividends are usually paid quarterly, but preferred-stock dividends are generally fixed, unlike common-stock dividends.

With all of these types, it is important to know the ex-dividend date because if an investor purchases the stock after that date, they will not be eligible to receive the dividend. 

Dividend Yield

One way to look at dividend-paying stocks is by their dividend yield. This metric measures the ratio of a company’s share price ratio to the amount it pays out in dividends, expressed as a percentage.

The formula for computing the dividend yield is:

Cash Dividend per share / Market Price per share x 100 = Dividend Yield 

For example, if a stock trades at $20 per share and pays an annual dividend of $1 per share, its dividend yield is 5%.

Stock Dividend Example

If a company distributes a 5% stock dividend to its shareholders, you would own five additional shares. If there are a million shares in the company, this will translate into 50,000 additional shares. If you owned 100 shares in the company, you’d receive five additional shares.

However, a stock dividend does not affect the value of the company. If the company was priced at $10 per share, its value would be $10 million. After paying a stock dividend, the share price would drop to $9.50 to reflect the dividend payout, leaving the company’s value unchanged.

Investing in Dividend Stocks

With so much in the news these days about how savings accounts are barely paying interest and how the stock market is so volatile, the topic of dividends has become an extremely popular one. 

Some investors, especially those seeking a more stable income stream, have built entire investment strategies around stocks with high dividends. 

The premise in building such a portfolio of dividend-paying stocks is that even if the stock price remains flat, at least the dividends could provide a steady source of money coming in. Hence, dividend stocks are sometimes considered less volatile than many other equities types and asset classes. Those searching for the best dividend stocks tend to be investors hoping for long-term capital growth with a steady income.

Dividend Investment Income 

Collecting an income from investments is one of the primary reasons some people seek out dividend stocks. Additionally, dividends can grow over time because most companies do not want to upset shareholders by lowering dividends paid. This contrasts to fixed-rate bonds, where the interest paid does not change. Some people also prefer dividend stocks because they are retired and not earning income via their job.

This article is provided for informational and educational purposes only.  It is not intended to be investment advice and should not form the basis of any investment decision.

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