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what are dividend stocks

10 Mins 21 Mar 2023 0 COMMENT

When planning to invest in the stock market, you consider the potential returns generated by a stock. You aim to profit from the increase in the market value of the stocks you hold. However, appreciation in stock prices is not the only source of profits in the market. Investors should also pay attention to the stock’s dividend offering. It is essential to understand the concept of dividends and dividend stocks to build a successful portfolio.

Dividend is part of a company’s profits which is shared with the shareholders. Dividend stocks represent an investment where the primary objective is to generate income in the form of dividend payments. Let us first understand the dividend meaning in detail.

What is dividend?

Equity shares represent a part of the ownership of a company. The equity shareholders are entitled to a share in the company’s profits and they have voting rights in the matters of the company. A part of the profit earned by the company is distributed to the shareholders in the form of dividends.

The company may choose to distribute dividends to shareholders in any manner, be it cash or cash equivalent stocks or assets. Most commonly, the dividend payment is made to shareholders in the form of cash.

How are dividend payments made?

Dividend payouts are done in certain steps. It is important to stay informed of pertinent dates related to dividend payments.

  • Announcement date – The company’s board of directors approves the payment of dividends in their meeting and declares their decision to distribute dividends among its shareholders.
  • Record date – The record date is the day fixed by the company to determine the eligible shareholders for dividend. The shareholders registered in the company’s record as of this date will be eligible to receive dividends.
  • Ex-dividend date – It is the date from which the stock does not carry or stops carrying the value of its next dividend.
  • Payment date – It is the date on which the dividend is paid or distributed to its shareholders.

Now, these dates will depend on the type of dividend the company opts for. The different types of dividend are special, preferred, interim, and final.

How is dividend calculated?

Dividend is calculated using the dividend payout ratio. Here, the annual dividend paid per share is divided by earnings per share.

Dividend payout ratio = Dividends paid

                                      Reported net income

Using the above-mentioned formula, you can easily calculate the estimated sum of money a company is offering to its shareholders as dividends. Alternatively, you can determine the sum of money the company chooses to reinvest.

The dividend payout ratio is a strong indicator of the company’s financial health. Refer to the following pointers:

  • A 100% payout ratio indicates the company is providing its shareholders more than its earnings.
  • A steady payout ratio translates to solid financial standing.
  • A 0% payout ratio indicates the company is likely in no position to offer dividends o its shareholders.

Understanding Dividend Yield

Dividend yield measures the quantum of dividends paid to shareholders in relation to the market value per share. To calculate this financial ratio, the dividend per share is divided by the market price per share and then the result is multiplied by 100. A high dividend yield reflects that the company pays a substantial share of its profits in the form of dividends.

What are dividend stocks?

Dividend stocks are stocks of those companies which pay out regular dividends to their shareholders. Generally, these stocks are issued by well-established companies with strong financials and growth potential.

Investing in dividend stocks is often seen as a low-risk investment, as they provide consistent income without the need to trade actively in the market to generate returns.

Among various dividend stocks, investors should look out for companies that show consistent profitability and have a fair track record of dividend distribution. Moreover, it should have a dividend payout ratio of 50% or higher. The company should also have a good overall dividend yield ratio of 3 to 6%.

What are the benefits of investing in dividend stocks?

  • Stock price appreciation

When a company declares dividends, more investors tend to purchase its stocks thereby creating a huge demand for the stock in the market and ultimately resulting in a surge in stock price.

  • Source of passive income

Profitable companies generally distribute dividends to shareholders periodically. Hence, dividend stocks are an additional source of income for shareholders as they consistently get dividends. These regular dividend payments can be seen as interest received on fixed-income securities.

  • Reinvest the dividend payments

If you do not wish to utilise your dividend payments, you can always choose to reinvest them. You can invest the money in stocks or any other financial instrument of your choice. This gives you a chance to maximise your investment earnings.

Bottom line

Investors looking for a steady stream of income can find dividend stocks attractive investment options. Dividends are a great way to supplement income, build wealth, and grow a portfolio. It is essential to explore the market conditions, consider various aspects, do your own research and select the right stocks for investment to maximise your returns.  

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