Understanding Dividend Stocks

When you invest in the stock market, there are a couple of ways to generate income. The first is by recognizing an increase in value for the shares you own. The second way is by receiving dividend payments. A company makes these payments to its shareholders as a reward for holding shares in their business.

What Is a Dividend Stock?

When a company decides to provide its shareholders with a percentage of the company’s earnings, it does so via a dividend payment. You can use this money any way you’d like or reinvest it back into the company’s stock. Investing in a dividend stock does require you to make wise choices when you’re deciding on the type of dividend stock to purchase.

Are Dividend Stocks a Good Investment?

The decision to purchase a stock that pays a dividend will often rely on its dividend yield. This figure is calculated by taking the total dollar amount of dividends received per share for a fiscal year and divide it by the stock price. Stocks that are paying dividends of 4 percent or higher offer a more attractive long-term yield than placing money in a CD or savings account. However, it’s important to consider a few factors related to the business before making a purchase, which includes the following:

  • Is the company generating positive cash flow?
  • What are future strategies?
  • Is the dividend payout a large percentage of their profits?

The survival of the business is essential. If a company pays too much for a dividend, it can become a struggle to initiate growth strategies or even remain stable. When a company has pushed financial figures to the limit internally, a high dividend yield may not be as attractive as it looks. If a company is paying too high of a dividend in comparison to its net income, it can be a red flag.

It’s best to find a company that keeps its finances in check when it is paying a dividend. Their fiscal responsibility can create a good way to diversify your portfolio

Looking at the Dividend Payout Ratio

The dividend payout ratio is the percentage of net profit being paid to shareholders. It’s derived by dividing dividends per share by a company’s earnings per share. It’s important to look for a figure that’s low as this means a company isn’t extracting a large percentage of its net profit for dividend payments. It should be able to sustain the current dividend payment it’s making.

Pros of Investing in Dividend Stocks

Compounding is one of the most potent ways you can increase the value of your portfolio. Each time you get paid a dividend, use it to purchase more shares of a company. Reinvesting will help generate an even larger dividend payment, which can then be rolled into more shares. This strategy benefits you by utilizing exponential growth. The original investment you make generates a specific return that’s reinvested, which continues on and on.

Appreciation in value is another advantage you can receive by investing in dividend stocks. When you’re looking for the best dividend stocks to buy now, it’s important to focus on the dividend yield as well as make sure that the company has strong fundamentals. Evaluating both of these areas will not only provide you with steady passive income, but it raises the potential for your dividend stock to escalate in price as well.

Cons of Dividend Investing

Dividend investing can create a steady income. The drawback of this is double taxation. The first taxation occurs is when the company you’re invested in pays taxes on their earnings, which is where your dividend payments are derived. If those taxes weren’t happening, your dividend payment could be more substantial. The second time taxes are paid is when you receive a dividend payment via your personal income, which must be listed on your tax form. This double taxation means you’re paying taxes as an individual and indirectly via the company.

Cutting or eliminating a payout is another con of dividend investing. A reduction can be seen as a negative for the company and adversely affect the stock price. Investor reactions can influence price direction, which means if several investors reject the change and decide to sell, the price of the stock will suffer.

Dividend stock investing can offer a higher stream of steady income than investment accounts with low-interest rates. It’s also a way to diversify but does require due diligence like most investments.

Ryan Kh

Ryan Kahn, known as a career coach and television personality. Ryan Kahn is founder of The Hired Group, author of Hired!