You may have seen the term “dividend” thrown around when looking at stocks to invest your hard-earned cash into. But what exactly is a dividend? Without going into too much detail, it’s a payment (in the form of cash or shares) from some of the earnings to shareholders, as declared by the board of directors.
What is a dividend?
A dividend is a payment made by a company to shareholders, subtracted from the company’s earnings. Dividends are usually paid in the form of currency, but there are instances where additional shares are released to those who own the stock instead.
Depending on the market where the company is listed, as well as the country of origin for the investor, dividends can be subject to tax. For the UK, a deal is in place that brings down the applied dividend tax from 30% to just 15% through a completed W-8BEN form.
The board declares how much will be paid to investors, which can be affected by stock price, market conditions, and how the company is performing. There are some companies that meet the requirement to become a dividend aristocrat.
Important dividend dates
There are a few important dates to bear in mind when considering dividend payments.
The company board declares the dividend amount to be paid to shareholders, which needs to be approved by stockholders before it’s released.
The date set as ex-dividend is essentially the cut-off point as to when shareholders will not be eligible for this dividend payment. For instance, if you purchase shares on June 15 but the ex-dividend date is June 14, you’ll not be eligible for the dividend.
You need to buy shares before the ex-dividend date.
The record date is the actual cut-off for being eligible for the dividend payment. This follows the ex-dividend date by a single trading day.
The final date is for payment. This is when the company pays shareholders the dividend, be it in the form of cash or shares.
How to search for dividend-paying stocks
It’s easy to search for dividend-paying stocks. Most brokerages display financial details for stock listings, which include dividend yield (if not, there are always handy sites like Seeking Alpha). It’s best practice to look for a payout ratio of around 5%. This maximizes return while not posing too much risk of a cut or the company being unable to cover it.
I’ve gone over some of the best dividend-paying aristocrats for the U.S., but really most older and well-established companies usually pay out smaller dividends, but these are reliable and have a solid history of dividend growth. Newer companies that pay higher dividend yields can be slightly riskier.
How dividends can help build a portfolio
When buying holding shares of a stock, unrealized gains (or losses) are present. You cannot make money from stocks unless you sell them, but this is where dividends can switch things up. With dividend investing, it’s possible to earn up to 5% on decent dividend-paying stocks per year to bolster your portfolio.
This provides additional cash to buy yet more shares and compound the effect. The more shares you own, the higher the dividend payout. The higher the dividend payout, the more shares you can buy each year. It’s also a safety net against market conditions.
Should the market fall, so long as you still receive dividend payments, your portfolio shouldn’t be negatively affected and this should help you hold out against the storm. Once strong companies come out the other side, dividends earned through the downturn will help catapult you into even better standing.