If your goal in life is to be wealthy, financially independent, or just to have more cash so you can buy more, investing is a great place to start. Assuming you have read out Getting Started With Bits of Stock Part 1 & Part 2, another fundamental starting point is understanding Dividends. As Bill Gates once said “If you’re born poor, it’s not your mistake. But if you die poor, it may be. So let's find out more about dividends and how they work.
What are Dividends?
Generally speaking, dividends are payments a company makes to share profits with its shareholders. They’re paid regularly and considered one of the ways investors earn a return from investing in stocks.
Companies can pay dividends at any time. These are known as special dividends. However, companies who pay on a fixed schedule, such as quarterly or annually, are known as regular dividends. For example, if you own 30 shares in Google and they pay $2.00 in annual cash dividends, you will receive $60.00 per year. However, not all stocks pay dividends. So make sure you’re choosing the right stocks.
Why Do Companies pay Dividends?
Companies pay dividends for a variety of reasons. These reasons have various implications for the people involved. For shareholders, dividends can be seen as a reward for having trust in the company. For companies, paying dividends is basically money going out of the company. These payments can also impact the share price.
Generally, it’s the more established companies that pay out dividends. This is usually the case as these companies are less reliant on the capital needed to pay out the dividends. On the other hand, high-growth companies, such as tech companies, rarely pay dividends because they need to reinvest their profits into expanding their business growth.
Understanding if a company has a high-value dividend declaration can often tell you that the company is doing well and is making good profits. However, this is not always the case, it can also mean the opposite. It’s not unheard of for companies that are not doing so well to maintain their dividends payments in an effort to keep up appearances. So make sure you research before investing.
Different Types of Dividends
There are different types of dividends. Usually, dividends are paid out on a company’s common stock. Although cash dividends are the most common, dividends can also be issued as shares of stock or other property. Here are the most common types of dividends:
Cash dividends - the most common type of dividend. Companies generally pay these in cash directly into shareholder’s brokerage account.
Stock dividends - instead of paying cash, companies can also pay investors with additional shares of stock.
Dividend reinvestment programs (DRIPs) - investors in DRIPs can reinvest any dividends received back into the company’s stock, often at a discount.
Special dividends - these dividends payout on all shares of a company’s common stock, but don’t recur like regular dividends. A company often issues a special dividend to distribute profits that have accumulated over several years and for which it has no immediate need.
Preferred dividends - payouts issued to owners of preferred stock. Preferred stock is a type of stock that functions less like a stock and more like a bond. Dividends are usually paid quarterly, but unlike dividends on the common stock, dividends on preferred stock are generally fixed.
Stocks that pay dividends can provide you a growing income. The easiest way to measure a dividend’s safety is to check how much a company pays out. If a company pays out 100% or more of its income, there could be something up. It’s said that investors look for payout ratios 80% or below. You can usually find the information on companies’ payout ratios on most financial or online broker websites.
When investing, make sure you choose the right stocks and consider reinvesting your dividend payments. Holding on to your investments for as long as possible means your money will only grow. So it will only be better for you if you’re in it for the long run. At Bits of Stock, once you claim your Stock Rewards and convert them into stocks you are eligible to receive dividends. We reinvest the dividends for you into the Stock similar to a dividend reinvestment program.