Dividends are bonus payments a company makes to its shareholders. Dividend investing, by extension, is when you buy stocks in a company that pays dividends. If you own these types of stocks, you will earn a percentage of the company’s profits.
Dividends act as a supplementary form of income. Cash dividends are the most common form of dividends.
Read on to learn more about dividends, dividend investing, and the various types of dividends.
What is a dividend?
A dividend is a distribution of profits. Dividends are given to a company’s shareholders typically when there is a surplus in profits. Similarly, dividend stocks are when shareholders collect additional shares instead of the traditional form of cash.
The distribution of dividends benefits both the company that hands them out and the investors who receive them.
Analyzing dividend distributions is a reliable way of determining the progress of a company. More consistent and substantial payments indicate that a company is successful and less likely to be affected by economic decline. Typically, dividends distribution policies are set in place by a company’s board of directors.
For investors and shareholders, dividends are another way of earning more income. Dividend stocks are capable of compounding or snowballing, just like interest rates. Upon receiving your dividend payments, the more frequently you reinvest that bonus and the more shares you own in a business, the more money you’ll earn since the resulting payments will grow bigger and bigger.
Additionally, research has shown that dividend stocks perform much better than non-dividend stocks. They are less susceptible to shifts in market trends and are therefore more steady means of income.
How do dividends work?
Again, dividends refer to the allocation of a company’s earnings, and there are three types.
The first is a regular dividend, which is the most common type of dividend. Shareholders earn these payments either monthly, quarterly, twice a year, or once a year.
The second is a special dividend, which is a one-time payment for shareholders if a company earns more profits than was initially projected.
The third and final type of dividend is a variable dividend. These are common in the oil and gas sector and are consistent payments, but amounts often vary instead of being a fixed value like the former two types of dividends.
Understanding dividend investing
A key term to be familiar with when talking about dividends is DRIP.
DRIP stands for “dividend reinvestment plan.” Specifically, this refers to reinvesting the dividends you earned and buying even more shares in a company instead of cashing them in. It can significantly boost your personal profits.
Another important term is dividend growth rates. Companies that boast a high dividend growth rate are growing companies. Therefore, the dividend payments themselves are lower, but since the business can – and most likely will – expand, you’ll earn more in the long run.
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4 things to look for in dividend stocks
One: Payout ratio. If a company has a lower dividend ratio, there is room for the payment amounts to increase. It is important to note, however, that ratios differ according to the industry.
Two: History of raises. If a company has a history of dividend raises, this indicates they’re likely to continue awarding dividend raises.. Gradual growth is more reliable than fast growth over a shorter period since the company cannot consistently maintain such rapid progress.
Three: High yield. Similar to the payout ratio, investing in stocks with a lower yield is wiser in the long term. In comparison, dividends that boost a higher yield usually won’t increase.
Four: Dividend policy. Before investing, it is best to be aware of any company’s policies.
The Dividend Aristocrats Index: What is it?
The Dividend Aristocrats Index is a collection of companies that have increased their dividends for at least twenty years in a row. Each company included in the index has provided investors with extra income during market booms and busts alike. They are amongst some of the safest companies in which to invest dividends.
Procter & Gamble
A product manufacturing company that owns a wide range of brands including Pampers, Downy, Gillette, Tide, and Charmin, Procter & Gamble continues to flourish because most – if not all – of its products are necessary staples in our daily lives. The company’s dividend payments have steadily increased for 64 years.
Coca-Cola is a parent company, and its influence extends into other brands such as Dasani, Minute Maid, and Powerade. Coca-Cola's dividend payments have increased consistently over the last 59 years.
Realty Income is a real-estate organization that invests in single-tenant properties. Each tenant signs a long-term rental agreement in which rent increases over time. Listed in January 2020, it is one of the newest members on the Index. Realty Income has been paying significant dividends to its investors for 50 years.
Johnson & Johnson
Very similar to Procter & Gamble, Johnson & Johnson owns an impressive array of brands and products for everyday use, including Tylenol, Band-Aid, and Benadryl, to name a few. Dividend payments have grown for 58 years and counting.
Yet another parent company that sells essential products, Target also brings in plenty of profits. The company has grown significantly in the past few years because of flourishing online sales and delivery services. Target's impressive dividends have been on the rise for 49 years.
Why do people invest in dividends?
Again, this is another way to earn money. Dividends directed into retirement savings accounts will grow tax-free until you decide to take out that money.
What is a dividend yield?
A dividend yield is a financial ratio that represents how much a company pays in dividends each year. The ratio is (dividend/price) and is a percentage. Yields will rise and fall according to changes in the stock market. Established companies usually have high dividend yields, specifically in the real-estate sector.
Are dividends safe?
Dividend safety refers to how likely it is that a company will continue to pay dividends at the same rate or higher. The higher the profits, the more money from dividends you will earn. A company’s profits are dynamic and depend on market trends. If profits fall, it’s likely a company won’t be able to pay the same rates, and the amount of money you receive will decrease. It all depends on the stability and the success of the business in question.
Before investing in dividends, always do your research.
What are the tax benefits?
Dividends labeled as “qualified” are eligible for tax benefits.
Dividends are taxed as regular income. But, if you hold onto your dividend stocks for a more extended period instead of selling them immediately, they will be considered “qualified,” or considered a capital gain, and you will be taxed less.
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