Playing the Dividend Game

Before I get started, I wanted to first apologize to the InvestingDecoded world for my recent absence. I know I haven’t posted in over a month. I assure you that I remain committed to InvestingDecoded and helping everyone learn as much as possible about investing. Many of you may already know the reason for my absence, but I’m back now, and I promise to be posting away regularly :-)

Now, let’s get to the fun stuff – dividends! I wanted to talk about dividends today because in a market like this, investing in stocks that pay dividends is a common ‘safe’ strategy. Investing in a stock due to its dividend (or potential dividend) is usually called a ‘Dividend Play’. Let’s discuss what a dividend is and how you can make your own plays.

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A dividend, in its simplest form, is a piece of the profits from a company paid out to its investors. When a company makes money, it has options on what to do with it. It can take that money and reinvest it in the hope that it’ll make a return in the form of a higher stock price in the future. This reinvestment can be anything ranging from expansion to paying down debt. Or, the company can return the money to investors in the form of a dividend.

When looking at a stock, you can easily see if it pays a dividend. These are displayed on a per share basis. You should also look at what’s known as the “Dividend Yield”. This is merely the annual amount paid as a dividend as a percentage of the stock price. The yield basically tells you how much of an annual return to expect from the dividend along if you bought the stock right now.

Who Pays Dividends?

You may have inferred from the above paragraph that not all companies pay dividends, and you’d be exactly right (pat yourself on the back :-)). A company is not required to pay a dividend, and many don’t. The ones that don’t generally tend to be companies that are significantly growing which requires them to reinvest their profits (a lot of cutting edge technology companies fall into this category). The companies that tend to pay dividends are those that are matured and are in relatively low growth industries. Examples include Coca-Cola, Altria Group (formerly known as Phillip Morris), and Boeing. These guys have been around long enough and have reinvested so much of their money that they can now afford to give some it of it back to investors.

There’s also another class of companies that pays dividends – and these guys tend to pay a lot. These are companies that tend to pay most or all of their earnings as dividends as a way to attract investors and are usually specific to certain industries. One such example is the Oil Shipping Industry. This is a very cyclical industry, and during good times, dividend yields can run as high as 20% - that’s right you’ll get a 20% return on your investment from dividends (the price of the stock can obviously affect the actual return). That makes for a very interesting proposition for investors!

How To Play Dividends.

Investing in dividend paying companies isn’t hard. You can just see the dividend amount and yield and decide if it fits with your investing strategy. But there are some things that you should be aware of before investing in a company primarily due to its dividend:

• Companies aren’t required to pay a dividend. They can cancel it at any time and doing that usually causes the stock prices to drop significantly. The primary reason is obvious – the risk/reward profile of the stock changes without the dividend, causing investors to sell. Another, more subtle reason is that there are many mutual and ETF’s that primarily invest in dividend paying companies. If one the companies they own cancels that dividend, they are forced to sell, sending the price down.
• Dividends are paid at a set schedule, usually quarterly. To qualify for receiving a dividend on a given quarter, you have to be a holder of the stock on a given date known as the Dividend Expiration Date. Only shareholders on record as of the Dividend Expiration Date are eligible to receive the payment.
• Focus on the dividend yield of the company more than the actual amount paid. Companies tend to try to keep the yield constant and consistent with industry standards. That means that if the price is going down, the chances that the dividend will be cut is increased.
• Take a look at the dividend history of the company. This usually gives a strong indicator of how the company will pay dividends in the future. Companies that pay dividends erratically may not be the way you want to go. On the other hand, there are companies (Altria is a great example) who not only pay dividends regularly, but also have a consistent record of increasing their dividends. Those are the guys you want to get into for dividend plays.
• Companies can also declare Special Dividends. These are one-time disbursements of profits to investors and are usually difficult to predict. I would tend to stay away from playing the Special Dividend game where you buy a stock in the hopes you’ll get a special dividend payment.
• Many companies offer Dividend Reinvestment Plans (DRIPs). This allows you to automatically reinvest your dividend to buy more stock and not receive the actual cash payment. You can decide to participate in a DRIP through your broker on a per company basis.
• Dividends are usually treated as ordinary income for tax purposes. That means that you have to pay taxes on them just like the taxes you pay for interest accrued from a savings account. You should receive a report from your broker telling you how much you were paid in dividends for tax reporting purposes.

Overall, dividends are a great way to get predictable income form your investments. In my investing, I try to invest more in companies paying dividends because that shows me a certain amount of stability in the business. In this environment, that’s worth a lot more than usual.

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.