Dividends and their workings

What is a dividend

By definition, a dividend is a portion of earnings a company distributes to its shareholders. Companies often pay dividends to attract new investors, and reward its shareholders.

How it works

A company decides to reward its shareholders with a cash compensation. Dividends are paid out on a per share basis, so a $1.00 dividend is $1.00 paid out for each share outstanding. If I had to guess over 95% of companies pay a quarter dividend, there are some companies that pay a dividend monthly.

If a company pays an annual dividend of $1.00/share, then its quarterly dividend would be $0.25, every 3 months. If a company pays $1.00/share monthly dividend, then around $0.0833, or around $0.08 a month is what the shareholder would get. We will dive into the dates to remember and what yield is next.

Dates to remember

Declaration date - Is the date when a company declares its dividend. A company will announce that shareholders at the market close of a specific date will receive dividends.

Record date - Record date is the date when shareholders must own shares in order to receive the dividends. If the record date is December 1, then who owns shares by market close on December 1st will receive a dividend payment.

Ex Dividend date - The day after the record date is known as the ex dividend date. Whatever the amount of dividend shareholders are to receive at its next payment, the stock automatically opens at the previous days’ closing stock price less the dividend amount. Theoretically since a company just spent $1.00 a share (or whatever the dividend amount is with respect to the company), it should be valued $1.00 less by the market (or how much the company’s dividend payout is to be). (IMPORTANT: If you buy shares after the record date, that is the ex dividend date, you do not get the dividend until the next quarter).

Pay date - This is the date when the shareholders actually receive their cash. Cash is distributed and your broker will deposit the money into your brokerage account. Nothing needs to be done by the shareholder, it is all an automatic system.

Yield

Now that we got the technical stuff out of the way lets talk about the important number, the dividend yield. Yield is basically what the annual dividend is divided by the share price. If you do not own shares, lets say of IBM’s stock, you are interested in IBM. You type in IBM into your brokerages platform and the stock’s data appears. Annual dividend is $6.54 per share. That means if you hold the stock for 1 year, you will get $6.54 for every share you own. At the time of this writing, IBM’s stock is trading at $142.32 a share. The yield is 6.54142.34 = 0.0459, or 4.59%.

The 4.59% I just calculated is the current dividend yield, that is what yield a new investor to IBMs stock would yield. Yields decrease when share price increases, and yields increase when share price decreases. Lets say IBMs stock price increases to $150, now its 6.54/150 = 4.36%, the yield has gone down. If you had bought your shares at $140, then no matter how high the share price goes to your yield is going to be 4.67%, as long as IBM maintains that $6.54 dividend amount.

Risks

In the end sentence of the last paragraph I stated “as long as IBM maintains that $6.54 dividend amount,” and the keyword(s) to lookout for is “as long as.” Just because a company pays a dividend does not mean it is obligated to. A company for whatever reason can announce a suspension, or an end to dividend payments. Boeing stopped dividend payments after it’s 737 MAX crises. February 2020 I believe was the last time Boeing last paid a dividend.

If a company raises its dividends that can be a good sign for cash flow growth. Keep in mind that dividends cost the company money, and it is willing to pay more, then that is good news.

If a company has a significant decline in share price that can be a warning sign that a company my slash its dividend. Hardship on a company is a strong signal of dividend payments being suspended because usually dividends are the first cost cutting measures a company endures.

Also keep an eye out for a company that may take on debt to pay its dividend. Those dividend payments may not be sustainable, and it is to be seen as a red flag.

Where to look

Traditionally buying individual stocks is the way to get some yield in dividends. There are other avenues to individual stocks though.

Dividend ETFs

ETF fund managers have created ETFs that invest in high dividend stocks. This can be a great alternative to buying shares of an individual company. Do your research to make sure the ETF is in line with what your investment goals are, and make sure you understand the funds objective by reading the prospectus.

Mutual Funds

Just like what I described in the ETFs section same can be said for mutual funds. Mutual Fund managers have set up dividend Mutual Funds that invest in dividend paying stocks. Just be sure the funds objective match your investing goals. Be sure to read the prospectus carefully to understand the mutual fund before investing.

Industries with some yield

Some industries can be proxies to bonds, that is when bond yields go down their stocks become more attractive. These are the dividend paying stocks, and one industry that comes to mind is the dividend paying utilities sector.

Real Estate Investment Trusts (REITs) are another dividend paying sector. A REIT is a landlord that has created shares of its company, and is obligated to pay around 90% of its rental income from tenants to shareholders. There are REIT ETFs and REIT Mutual Funds, so do your research to get some dividends.