What is Dividend Investing?

Written by , March 12, 2012

What is Dividend InvestingThere are different ways to invest, including stocks, bonds, mutual funds, exchange traded funds, certificates of deposit and numerous other investment vehicles. Even if you decide to invest in stocks, you’ll still have to choose between different types of stock profiles, including growth stocks and speculative stocks.

One popular type of stock investment strategy is investing in companies that pay regular cash dividend to their shareholders. Some investors believe that assets which generate regular income can be preferable in many respects to relying solely on the capital gains prospects of non-dividend paying stocks. Many dividend paying companies are large blue-chip companies that are leaders in their markets.

Here is some information and advice for coming up with your own dividend investing strategy.

  • Dividend Yield. A given stock’s dividend yield is a percentage that’s calculated by dividing the amount of dividends that are paid for a single share of stock over the course of a year, by the market price of that share. For example, a company that pays a $0.55 per share dividend each quarter has a yield of 2.93% when the market price of the stock is $75 per share. (The calculation is (0.55*4)/75 = 0.0293.) Because both the dividend amounts and share price change over time (in fact, the share price is likely to change many times over the course of the day), the yield will also change over time.
  • Higher Dividend Rate Doesn’t Always Mean a Better Investment. New dividend investors are often tempted to seek out those companies that pay the absolute highest dividend yield. The thinking is something along the lines of “why should I settle for a blue-chip company that pays a 3% dividend when company X pays a 12% or 15% yield?” The answer is simply that in many cases a significantly higher than market dividend yield is a sign of an unsustainable yield, a company that will soon experience significant financial problems, or both of those things.
  • Pay Attention to Dividend Coverage. “Dividend coverage” is a measure of how much of a company’s cash flow goes towards paying the dividend to its shareholders. The lower the dividend coverage percentage, the better. A lower number means that the company still has plenty of cash left over to expand and grow the business, even after paying the dividend. A company that’s paying too much of its cash flow towards the dividend might have difficulty maintaining that dividend rate in the near future, or even growing its business.
  • Plan For Dividends, But Don’t Rely on Them. There are many companies that have increased their dividends every year for the last 10, 20 or more years. While this is often the sign of a strong company that will continue to increase (or at least maintain) its dividend in the future, there is never any guarantee of future dividends. Companies change, markets change and the world changes. During the market downturn of late 2008 and into 2009, for example, hundreds of companies cut or even eliminated their regular dividends. While many of these companies have since reinstituted their dividends, some of those have only done so at greatly reduced rates.
  • Dividend investing can be a great foundation of your portfolio. By selecting a good balance of strong companies that have a history of paying consistent dividends, you’ll have cash flow from your dividends to help mitigate any market downturns.

    Tags: ,

    • Twitter
    • Facebook
    • Digg
    • Delicious
    • Reddit
    • Stumble
    • Design Float
    • LinkedIn
    • MySpace
    Subscribe   Share/Bookmark

    Leave a Reply