Dividend Definition: What Is Dividend?
Suppose you start a lemonade stand, your friends and family help you monetarily and become investors (shareholders). After a year in business, lemonade stand has a net income of $20,000, after all expenses and taxes. You (and the board of directors) have to make a decision – what to do with the $20,000 now? You can either put it back into the business for growing it or you can distribute the profit, as ‘dividends‘, among your shareholders, or a bit of both! How much ‘dividend yield’ would would your investors get compared to their investment? On what date would you check your books to identify which investors qualify for the dividend payout? We will discuss everything about dividends in the article -rationale behind dividends, dividend rate vs dividend yield, date of record, ex dividend date etc. and take a look at some dividend paying stocks and ETFs.
If the board of directors decides that it’s best to give away some part of the profits as dividends, then the company gives out dividends to reward the investors, else reinvests the profits in future growth opportunities.
In general, most mature companies such as AT&T, Apple, Verizon etc. pay out dividends to the shareholders.
Dividend Payout Ratio
Out of the $20,000 net income, if you (and the board of directors) decide to pay out $8,000 as dividends to investors, and retain the remaining $12,000 for investing in future expansion or some other business related projects, your business would have a dividend payout ratio of 0.4 or 40%
Dividend Payout Ratio: Dividend paid out / Net Income = $8,000 / $20,000 = 40% or 0.4
Retained Earnings: 1 – Dividend Payout Ratio = 1 – 0.4 = 60% or 0.6
Alternatively, Retained Earnings: $12,000 / $20,000 = 60% or 0.6
What Is Dividend Yield?
Dividend yield is the ratio of annualized dividend and the price per share of the stock.
Dividend Yield Formula
Suppose a stock paid out dividends of $1.50 per share in Q1, $1.75 per share in Q2, $2.00 per share is Q3, $2.25 per share in Q4, the total annual dividend paid is $1.50 + $1.75 + $2.00 + $2.25 = $7.50
If the stock is now trading at $200 per share, the trailing 12-month dividend yield = $7.5 / $200 = 3.75%
Pro Tip: Before investing in stocks with high dividend yield, investors should investigate whether the stock is increasing the dividend or whether the price of the stock has declined, causing the dividend yield ratio to go up.
The total annualized dollar amount, $7.50 in our example, is called the dividend rate. It’s different from the dividend yield which is expressed as a percentage.
Types of Dividends
A cash dividend is a payout in the form of cash. For example, you own 100 shares of company, company pays out quarterly cash dividend of $1.50 per share; you’d receive $1.50 * 100 = $150 as cash dividend.
You may choose to enroll in DRIP (Dividend reinvestment plan), so that the $150 gets used to purchase shares at the market price (say $200/share). $150 / $200 = 0.75 shares will automatically get added to your account.
A stock dividend is a payout in the form of company’s shares instead of cash. For example, you own 100 shares of company, company pays out quarterly dividend of 0.05 share/share held. 100 * 0.05 = 5 shares gets added to your account.
Important Dates for Dividends
Ex Dividend Date
Ex-dividend date is the date on or after which a stock dividend is not paid to a new buyer.
For example, a company declares a dividend of $1.25 per share with a ex-dividend date of 18 November 2020. If an investor buys 10 shares before the ex-dividend date (say 17 November 2020), and 5 shares on 18 November 2020 (ex-dividend date), she is eligible to receive her dividend for that quarter on only the 10 shares (i.e. $1.25 *10 = $12.5 ) purchased before the ex-dividend date. She will not receive the dividend on the 5 shares purchased on ex-dividend date.
Date of Record
The date of record is the day the company will check its record books for who owns how many shares. Using the records on that day, the company will pay out the dividends to the investors.
Generally, the date of record is one business day after the ex-dividend date. It takes 2 business days to update the record books, hence in the example only the shareholders who are on books before the ex-dividend day qualify to receive the dividends.
For simpler understanding, investors can just focus on the ex-dividend date – i.e. buy before the ex-dividend date, and hold it for at least the ex-dividend date to qualify for the quarterly dividend.
Dividend Investors invest in divident stocks and dividend ETFs for many reasons.
- Generally established companies pay dividends, and investing in established companies are reassuring for investors.
- Cash flow – some investors need regular cash flows, and dividends help them achieve that objective.
- Dividend stocks tend to be less volatile than other stocks, hence investors feel more protected against a downturn or a stock market crash.
- While some investors look for high yield, some others look for dividend growth that would ensure better cashflows in the future.
Dividend Paying Stocks
Using the screeners, such as one on WeBull, it is easy to identify the stocks that pay dividends.
Dividend for Apple
Apple’s trailing twelve months dividend yield is 0.69% as of Nov 2020.
Dividend for AT&T
AT&T’s trailing twelve months dividend yield is 7.36% as of Nov 2020.
Dividend for IBM
IBM’s trailing twelve months dividend yield is 5.56% as of Nov 2020.
Dividend for 3M
3M’s trailing twelve months dividend yield is 3.43% as of Nov 2020.
Dividend for Amazon
Amazon doesn’t pay dividends to stock investors, as of Nov 2020.
If you don’t want to screen and pick individual stocks that pay dividends, you can choose an ETF instead. Dividend ETFs are a great way to invest and diversify at the same time in dividend paying stocks in a very easy manner.
The dividend ETF will invest in dividend paying stocks, and will pay the investors some dividends on a regular basis. The fund manager of the ETF does the job of investing in well researched dividend stocks so that the investors in the ETF (people like you and mw who just buy the ETF instead) don’t have to do the heavy lifting.
The investors have a choice to either cash out the dividends or reinvest it for more growth in the future – based on their individual goals. A reinvestment will enable the investor to buy more shares of the ETF and build more wealth in the long term.
Vanguard Dividend ETFs
ETF for High Yield from Vanguard: VYM (see details here)
Dividend Growth ETF from Vanguard: VIG (see details here)
M1 Finance Pie with Dividend ETFs
Here’s my dividend pie on M1, with target dividend yield of approximately 4%, and expense ratio of 0.29%
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Updated: January 13, 2021 by FinPins