All about dividends
Credit to Author: THE MANILA TIMES| Date: Sun, 03 Nov 2019 16:20:45 +0000
A company can do four things to its income. Reinvest it into the business. Buy other companies. Repurchase its own shares or simply pay cash dividends. The disadvantage of dividends is that investors have different desired dividend yields.
There is also the final tax that reduces the net dividend an investor receives. Instead, an investor may simply sell an amount he needs every period and create his own desired rate of dividend. The problem is that stock prices are volatile and could cause you to sell at lower prices just to get your periodic needs.
A dividend is a distribution of income of a company to its shareholders. It may be in cash, property or stocks, or all of them. In this article, we’ll focus on cash dividends from common stocks.
Investors buy stocks to receive a decent return while still waiting for the share price to go up. Because of this, studies show that dividend-paying stocks tend to be less volatile than non-dividend paying stocks, as investors can actually afford to hold it during volatile times.
This was termed the free dividends fallacy from a paper by Samuel M. Hartzmark and David H. Solomon titled “The Dividend Disconnect.” Their paper shows that investors trade as if dividends and capital gains are separate. Not realizing that dividends come at the expense of price decreases.
Behavioral trading patterns exclude dividends in price changes. Investors hold high dividend-yield stocks longer show less sensitivity to price changes. They found out that demand for dividends is higher in periods of low interest rates and poor market conditions, which lead to high valuations and lower future returns for dividend-paying stocks.
Investors also rarely reinvest dividends into the same stocks, instead purchasing other stocks. This creates predictable market wide price increases on days of large dividend payouts, concentrated in non-dividend paying stocks.
Companies that pay dividends could signal it’s profitable. It’s also a sign of liquidity and healthy financials. Not all companies, however, pay dividends. High growth startup companies may be better off not paying any cash dividends and should reinvest their income instead. Mature companies such as utilities are more likely to pay a higher dividend as their growth slows and capital requirements go down.
How do we find a good dividend stock? We can start by looking at stocks with a good dividend yield. The formula of dividend yield is annual dividends per share divided by the current stock price. Nowadays, online stock screeners can help us find undervalued dividend stocks.
You can also look at the historical income and dividends of the company. You want to see consistent growth in both earnings per share and dividend per share. If the stock is newly listed, check their dividend policy. This will give an idea how much dividends you might receive in the future. You will also observe that mature companies would give a more consistent but lesser increased amount of dividends.
Look at the payout ratios. Payout ratio is the ratio that a company pays out as dividends versus how much it makes. A payout ratio of 50 percent or less is generally a good sign that the company is earning enough to give dividends, and has still something left to reinvest in the company to grow it. Companies that pay out all of its earnings might signal that it does not see any growth area in its business.
Ensure that the debt of the company is not growing more than needed. Comparing the ratio of debt and equity may be useful. We want to make sure that dividends are from earnings and not from borrowings.
Return on equity (ROE) is also useful to be able to spot if the returns on capital are increasing or at least stable. Lower ROE may mean less income or that more capital is needed to increase income. More capital needed to sustain ROE could mean lower dividend payouts in the future.
Just like your wife’s birthday and your anniversary, there are also two very important dates you have to remember in dividend investing. First is the ex date. It is the cut off date where an investor loses the right to the declared dividend. In order to be qualified for a dividend, you have to buy it before the ex date. Second is the payment date. Just like salary day, it is the date where you will finally get to receive your cash dividends.
Dividend investing can be a great way to produce passive income while also growing your portfolio. When you buy shares of a high-quality dividend growth stock at a cheap price, even while doing nothing, you will compound your investment over time. Dividend stocks are the gifts that keep on giving.
Josefino Gomez is a registered financial planner of RFP Philippines. To learn more about personal-financial planning, attend the 80th RFP program this December 2019. To inquire, e-mail info@rfp.ph or text <name><e-mail> <RFP> at 0917-9689774.
JOSEFINO R. GOMEZ