The nice little gift of stock dividends
It’s certainly something to look forward to once every three months. The mailman delivers a check to you, issued by a company whose stock you own. It feels like a nice little – or not so little – gift, and one that you can count on receiving for the foreseeable future.
You can save it, invest it or spend it any way you want to. It’s a stock dividend.
Video: The Power of Dividends
A percentage of the profits
When you buy stock shares, you own a piece of the company that issued the stock. This can entitle you to a percent of the profits the company makes. If the company is making money, it has two alternatives: It can reinvest the money back into itself or distribute it to shareholders as a dividend. Many companies do not choose to offer stock dividends; instead, they reinvest profits in hopes of financing future growth. Companies that can foresee significant potential for expansion into existing and new markets high-technology companies, for example, may choose not to offer dividends. Investors in these companies make money when the value and therefore the desirability of their shares rise because of this growth. Older, established companies; utilities, financial institutions and “blue chip” corporations, whose potential for growth is not as great are likely to offer dividends instead of the promise of ever-rising stock value.
The company’s board is in complete control
No matter what kind of company is selling shares, whether or not it is turning a profit and growing, it does not have to distribute dividends. The corporation’s board of directors solely can decide to begin or discontinue and raise or lower a dividend at any time. If the company loses money, it can suspend its dividends. The board can decide when, how and how often to make distributions. Companies that decide to distribute dividends usually do so on a quarterly basis, and in cash. Dividends received by investors from the profits of a corporation are usually taxable as ordinary income.
Investing for dividends in not for everyone
Investing in a dividend-paying company is not for everyone. Speculative investors focused on the short term may not want to hold a dividend stock long enough to receive a single check. Yet for others retirees or those planning ahead for retirement, the vagaries and volatility of the stock market prompts investment in dividend-paying stocks so as to ensure a relatively reliable and constant income stream.
Compounding gains through reinvestment
Just as a company can choose to reinvest its profits back into itself, a shareholder can choose to reinvest his or her dividends back into a company by using the money to buy additional shares. It’s something like letting interest accumulate in a savings account rather than spending it. Reinvestment allows you to compound your gains. The more shares you own (all other things being equal), the more income from dividends you are likely to receive and be able to reinvest.
Calculating the dividend yield
One final concept regarding dividends is called the dividend yield. To calculate this, take the dollar amount of dividends paid out by the company in a year and divide that number by the company’s current share price. If the annual dividend is $2 per share and the stock price is $200 per share, the dividend yield is 1%. The higher the yield, the more income you stand to make through dividends.