Investing for Beginners: A Short & Easy Intro to Dividends

Shady financial advisor: Hey you! Want to make some money with stocks? AMC is going to the moon! 🚀🚀🚀

No doubt some people have made a lot of money with highly risky trades involving memestocks like AMC. If you don’t have the stomach for that level of risk, there are much safer ways of making money in the stock market.

Trusty financial advisor: Have you heard of dividend stocks?

What are Dividends?

Dividends are a portion of a company’s profits that are paid out to stockowners. If you own a stock that pays dividends, that’s money that’s going into your pockets.

Corporate Finance Institute provides a good overview of the dividend process:

“1. The company generates profits and retained earnings

2. The management team decides some excess profits should be paid out to shareholders (instead of being reinvested)

3. The board of directors approves the planned dividend

4. The company announces the dividend (the value per share, the date when it will be paid, the record date, etc.)

5. The dividend is paid to shareholders”1

Dividends are paid out at different time intervals throughout the year. Most companies pay dividends four times a year or quarterly. Monthly payment of dividends is also common.

Not every company pays dividends. Many companies choose to reinvest their profits back into the business rather than payout profits to stockowners. Companies that are growing at a fast pace usually don’t pay dividends; they use their profits to continue expanding.

Mature companies are more likely to pay out dividends. With maturity comes stable profits and growth rates. That stability allows mature companies to pay more dividends to stockowners.

How Much Money Can You Make from Dividends?

Ahh, this is what you really wanted to know. You don’t care that a company’s board of directors approves the dividend. You care about the money! Jokes aside, here’s a look at the numbers.

To find out how much you would make from an investment in a dividend stock, look at the dividend yield. The dividend yield is standard info that is displayed when you look up a stock through your brokerage account or on a finance site like Yahoo Finance.

coca cola stock info

Looking at Coca-Cola Company’s (KO) info from Yahoo Finance, we see that the company is expected to pay $1.68 in dividends in the coming year. This puts the dividend yield at 3.09%.

The dividend yield is calculated by dividing annual dividends per share by the price per share. In Coca-Cola’s case, the annual dividend per share is $1.68 and the price per share is $54.44.

Dividend yield = $1.68/$54.44 = 3.09%

Yahoo Finance reports the forward dividend yield. A forward dividend yield takes a company’s most recent dividend and annualizes it. Remember that most companies pay dividends on a quarterly basis (four times a year).

Coca-Cola’s last dividend was $0.42. Coca-Cola pays out dividends four times a year. To get an idea of what Coca-Cola will pay out in dividends over the coming year, we take the most recent dividend of $0.42 and multiply it times four to get $1.68, the number we see in Yahoo’s report.

You can also calculate the trailing dividend yield instead of the forward dividend yield. The trailing dividend yield takes the dividend payouts that were paid during the last year and divides by the current share price. The difference is that the forward only takes the most recent dividend into account, and the trailing looks at all the dividends from the last year. In any case, the dividend yield gives you an estimate of how much you will be paid in dividends if you hold the stock for the next four quarters.

Using our dividend yield for Coca-Cola, you would expect to be paid around $154 in dividends a year if you bought $5,000 worth of Coca-Cola stock.

$5,000/$54.44 = 91.84 shares

You would be paid $1.68 per share.

91.84($1.68) = $154.30

Dividends are paid into your brokerage account. Keep in mind that you do have to pay taxes on dividend income. Instead of receiving the dividend in your brokerage account’s cash balance, you can set up a DRIP. DRIP stands for dividend reinvestment plan. Under a DRIP, dividends you receive will be used to purchase more of a company’s stock instead of going into your cash balance. DRIPs can be good if you know you are going to continue investing in a company over the long term. Under a DRIP, you’ll still have to pay taxes on the amount you would have received as cash, however.

Dividend Hikes & Cuts

If a company decides to hike or increase its dividends, it’s usually a good sign. It shows that a company’s earnings and expectations for future earnings are strong. It also speaks to the financial health of a company; it has its debt under control. Investors often get excited when a company announces an increase in dividends, causing the price of a stock to move upwards.

Dividends play an important role in how investors value the stock of a company. Investors expect to profit from stocks either through the price of the stock moving up or receiving dividends. In other words, the current price of a stock is dependent on the future cash flows (price increases or dividends) that it can provide to investors. There is even a financial model, called the dividend discount model, that tries to estimate the true value of a stock based on dividend payments. How dividends affect the price of a stock is something to think about as an investor.

If a company cuts or decreases its dividend, it could be a sign that the company is in trouble. Profits may be falling, or there may be a struggle to keep up with debt payments. When a company announces a dividend cut, it often leads to a fall in the price of a stock. A dividend cut is not always bad news. A company might decide to decrease its dividend if it’s preparing to do a stock buyback or purchase another company.

Some companies have consistently increased their dividends for a long period of time. These are the royalty of dividend stocks, known as dividend aristocrats.

Example of a Dividend Aristocrat

“A Dividend Aristocrat is a company in the S&P 500 index that has paid and increased its base dividend every year for at least 25 consecutive years.”2

An example of quality dividend stock is AbbVie Inc (ABBV). It also happens to be a dividend aristocrat.

Bloomberg provides a short description of the company:

“AbbVie Inc. researches and develops pharmaceutical products. The Company produces pharmaceutical drugs for specialty therapeutic areas such as immunology, chronic kidney disease, hepatitis C, women’s health, oncology, and neuroscience. AbbVie also offers treatments for diseases including multiple sclerosis, parkinson’s, and alzheimer’s disease.”3

Looking at ABBV’s numbers from Yahoo Finance:

abbvie stock info

We see that ABBV has a dividend yield of 4.83%, which translates to a payment of $5.20 over the coming year. Besides a healthy dividend yield, the charts shows that ABBV’s stock price has had impressive growth over the last five years. The price has increased about 70% in that time frame, which is about 14% per year.

Adding the dividend yield of 4.8% to the growth rate of 14%, you might expect an investment in ABBV to grow by 18.8% in the next year.  This is just a quick and dirty estimate, so the actual outcome may be quite different. The point is that ABBV pays a respectable dividend, and the price of the stock has had impressive growth over the years.

If picking individual stocks isn’t your thing, you can buy a share of a dividend ETF. When you a buy a share of a dividend ETF, your investment is automatically diversified among a collection of dividend stocks. There is even an ETF that holds all the dividend aristocrats called the ProShares S&P 500® Dividend Aristocrats ETF.

Dividend Dates

While they aren’t as important to remember as the date of your marriage, there are a few dividend dates that are worth remembering.

Announcement date – the date a company announces that it will pay a dividend

Record date – the date the company determines who its shareholders are, and thus who gets paid dividends

Ex-dividend date – occurs before the record date, purchase a stock before the ex-dividend date to be eligible to receive a dividend

Investopedia’s video explains the dates well.

Wrapping Up

Research a company and its dividend yield. Buy the company’s stock if your research shows it to be a worthy investment. Collect dividends if you purchased before the ex-div date. Watch out for dividend hikes and cuts. Now, you know the basics of dividends.

Disclaimer: This is not investment advice. I am not a financial advisor. I do not own any positions in any ETFs or stocks mentioned.

Endnotes

1. “What is a Dividend?,” Corporate Finance Institute, accessed September 18, 2021, https://corporatefinanceinstitute.com/resources/knowledge/finance/dividend/.

2. Jason Hall, “S&P 500’s Best Dividend Aristocrats,” The Motley Fool, published July 21, 2021, https://www.fool.com/investing/stock-market/types-of-stocks/dividend-stocks/dividend-aristocrats/.

3. “AbbVie Inc,” Bloomberg, accessed September 18, 2021, https://www.bloomberg.com/profile/company/ABBV:US.

Graphics for Coca-Cola and AbbVie from Yahoo Finance.

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