14 Questions to Ask Before Investing in Dividend Stocks
Frequently Asked Questions About Dividend Investing
One of the most common ways to make money in the stock market is by buying shares at a low price and later selling them at a higher one. But if you are busy with your daily responsibilities, it may be difficult to make time to trade stocks during market hours. Another way to make money in the stock market is through dividend investing.
Dividend investing sees companies reward shareholders for owning shares of the business. You may be thinking this sounds to good be true, but this is not the case. Shareholders are paid using the company’s earnings, since they are considered part owners.
Companies do this for a few reasons, including because they have predictable revenue and because can afford to. The business could also be cash-flow heavy machine and with few investment opportunities.
Dividend-paying companies also attract long-term investors, resulting in lower volatility, as seen in the day-to-day price movements.
This article will go through other questions, how to buy dividend stocks, how to receive dividends, and how long shares need to be owned to receive a dividend. Below, you will learn all you need to know about dividend investing for beginners and how you can earn a steady income.
What Are Dividend Stocks?
Dividend stocks are the stocks of companies that pay out part of their earnings to shareholders. Investors receive a return in the form of a dividend payment and the share price performance.
Dividend stocks fall under a few different categories. The first would be dividend growth stocks, which belong to companies that grow their dividend and see growth in both gross and net income.
Another would be high-dividend stocks, which come from companies that offer a higher return based on the income returned to shareholders. Normally, this dividend is not changed since a higher return is being provided.
Lastly, some companies pay a dividend based on their earnings. These are businesses that see a lot of volatility in their earnings based on the performance of the economy.
The category a dividend-paying stock would fit into is based on its history. If it has increased its dividend year after year, then there is a high probability that more dividend hikes could occur. And if the payment is historically steady, it’s more likely to stay that way.
What Is Meant by a “Cash Dividend?”
A cash dividend is a payment made by the company to shareholders. This is normally a cash payment that comes from the company’s earnings. The strategy is to purchase a stock and receive cash income for your time in the investment.
The board of the directors of the company are the ones who decide if a dividend will be paid, how much will be given, and the date it would be received.
How to Buy Dividend Stocks
There are many different ways to purchase a dividend-paying stock.
The most common way to acquire dividend-paying stocks is by purchasing shares through a broker. One method is a discount broker, which means that you must purchase the shares electronically through an online brokerage account, provided through a large financial institution. Each time you decide to purchase or sell shares, it will incur a small commission fee.
Another option is an in-person broker handling all your trades on your behalf. There will be times the broker will come to you and recommend an investment, or you will contact them to request they place a trade. The shares are owned electronically and the commission rate is higher than that of a discount broker.
There are two other methods that could be used to purchase shares without a broker, through a transfer agent. Details are further below.
Advantages of Using a Broker
If you are looking to have a diversified investment portfolio, using a broker is the best method.
There are many free research tools available when logging into your brokerage account(s), such as analyst recommendations, info regarding competitors, and detailed company fundamentals.
In addition, the dividend payment will be deposited directly into the cash portion of the brokerage account.
If you are using a broker you are actually in contact with, they could give you suggestions on investments that may be under-owned or ignored. You will also have access to someone that spends most of their time following the markets, so you can pick their brain for information.
Disadvantages of Using a Broker
Every transaction that is completed in your brokerage account will incur a commission cost. Over time, if you are a very frequent trader, these fees can add up and greatly impact your total return.
Since it is easy to log into your discount brokerage account in a matter of minutes, you could make the mistake of making investment decisions based on your emotions. If so, it could result in you moving away from your initial investment plan and having weaker returns.
If dealing with an actual person as your broker, you could be given poor advice. You can also be told to trade more often in your account, so your broker can meet his job quota and earn his commission checks.
Regardless of the type of broker, there are capital requirements that must meet the minimum investment of the account. If you don’t have a enough to meet the broker’s requirement, then it means there will be delays in starting an investment portfolio.
How to Buy Dividend Stocks Without a Broker
If you have your eye on a company that you wish to purchase and would like to do it without a broker, it is possible. Shares can be purchased through the transfer agent that the company is working with. The transfer agent partners with the company since it specializes in managing record keeping of shareholders.
Investors have two choices: purchasing physical share certificates or having the transfer agent hold the shares electronically on your behalf.
If you decide to to purchase physical shares, a certificate will be mailed to the address that is provided to the transfer agent. As for dividend payments, a check will be mailed to the same address that the physical shares were delivered to.
Physical shares also have a cost associated with purchasing or selling them, which is determined by transfer agent.
If you decide to hold the shares electronically with the transfer agent, then you will access to an account online with your holdings. A statement will be mailed to you which will detail your holdings. The dividend payment it will be deposited into the account that is held with the transfer agent.
Depending on the transfer agent, there may be times where purchasing or sell shares electronically requires a fee. However, not every transfer agent charges for this service, and others only do so on a case-by-case basis.
One feature exclusive to investors holding their shares digitally is the ability to use the cash dividend to purchase more shares of the company. This is done through a dividend reinvestment program (DRIP), a program that is used to purchase more shares of the company using the dividend payment.
Disadvantages of Not Using a Broker to Purchase Shares
If you are looking to diversify your investment portfolio, then this could result in a lot of paperwork for yourself. For instance, say you go to 20 different transfer agents to purchase 20 different stocks. This would result in you spending a lot more time then you likely wanted to.
Another disadvantage is if you have physical shares, in which case you will receive your dividend payment in a form of a check. There could be a delay in you receiving it if there is a backlog or delays with the postal service. Or even worse, the check could be lost in the mail altogether.
One disadvantage of owning physical shares is if the shares happen to get lost or destroyed, in which case you must contact the transfer agent to mail you new ones. This at the end of the day will result in you paying for another copy of the physical share certificate.
If you are looking to sell your position, there could be delays and the shares could be sold at an unfavorable price. If you own physical shares, then you must mail them to the transfer agent so they can be sold, but they could make a huge move during this time.
Not all companies that are listed on the various stock exchanges will be available to be purchased without a broker. Purchasing shares with no broker is typically available for larger-cap companies. This could result in a lost investment opportunity.
Advantages of Not Using a Broker to Purchase Shares
There are no minimum capital requirements in order to purchase shares directly from a transfer agent.
If you are a big believer in the company and would like to continue to purchase the shares on a regular basis without incurring a commission, it is possible to do so through the transfer agent. Depending on what your comfort level is, you can purchase shares on a bi-weekly, weekly, or even monthly basis; this is known as dollar cost averaging. The advantage of this will be that you purchase shares at different prices with any issues with trying to time the market.
One big advantage of transfer agents over brokers is their ability to purchase partial shares. Whether you are dollar cost averaging or enrolled in a DRIP program, every dollar will be used to purchase more shares to add to your bottom line. In the case of the broker, dividend income to purchase more shares can only buy whole shares and the money left over will sit in the cash portion of the account.
How Do You Get Dividends?
How the shares are owned it will determine how you will receive the dividend payment. The frequency of the payment will differ for each company, who get to decide their own. Typically, dividends are paid out on a monthly, quarterly, semi-annual, or annual basis. Below is how dividend will be paid to you depending on how the shares are owned:
- If you own physical shares of the dividend, then a check will be mailed to you.
- If you own the shares through the transfer agent, then the cash will be added to the cash balance of the account.
- If you own the shares through your broker, then the shares will be added to the cash balance in your brokerage account.
How Are Dividends Calculated?
Each company that is paying a dividend will be different based upon their own performance and earnings. In addition, the frequency of the dividend payment needs to be considered to determine how much is received via dividends.
If a company pays a quarterly dividend, then that dividend must be multiplied by four; the result will be the annual expected dividend payment.
For example, let’s say company XYZ pays a quarterly dividend of $0.10 per share. The annual dividend that would be expected as a result would be $0.40 (4 x $0.10=$0.40).
If a company pays a dividend on a monthly basis, then the current monthly dividend must be multiplied by 12 to determine the annual dividend payment. So if company BCD pays a monthly dividend of $0.25 per share, then the annual dividend would be $3.00 per share (12 x $0.25 = $3.00).
How Much Do You Get from Dividends?
In order to determine the return that you will receive via the dividend payment, you must calculate the dividend yield. The yield is the percentage return of the dividend based on the price the shares were purchased at.
How Long Do You Have to Hold a Stock to Get the Dividend?
The answer to this question is simple: just one day.
There are a series of dates that are associated with one dividend payment. Knowing this information is very important. Below are the dates to look out for when owning or looking to purchase/sell a dividend-paying stock.
|Term of Each Date||Important Dates|
Declaration Date: This is the date that board of directions approves the dividend payment. This date also informs investors of when the shares of the company need to be owned by and when the payment date will be.
Ex-Dividend Date: This is known as the cutoff date to own the shares. The shares need to be owned any day before the ex-dividend date. In this example, the shares would have to be owned by April 11 or earlier. If you decide to purchase the shares on April 11, then sell the shares the next date, you would still be entitled to receive the dividend payment (this would result in owning the shares for just one day). Purchasing the shares on the ex-dividend date (April 12) or later will mean no dividend payment.
Record Date: This is the date that the company will record all eligible shareholders to receive the dividend on the payment date.
Payment Date: This would be the date that the payment will be made to shareholders.
How to Invest in Dividend Stocks?
Before making an investment into a dividend-paying stock, there are a few things to consider to ensure that the dividend can continue well in the future and your investment can be preserved.
The current share price and dividend yield are both very important and should not be used solely to determine an investment.
I would recommend sitting down and sorting out a list of goals, such as your purpose for investing. A couple examples are to use the dividend payment for early retirement or your children’s education. If you are a dividend investor who is going to be concerned with inflation, then the best choice might be dividend growth stocks.
Once you know your goals, then understanding the business of the potential investment is next. If the business model is very complex and you cannot describe it to a non-investor, I would recommend to stay away. The investment should be easy to understand so you needn’t worry about how the company will perform in the future.
Next, look to see where future growth could come from. For example, the company may be trying to expand globally or has made a recent acquisition.
Another important area is the history of the dividend payment. If the payment has been steady or growing, there is a possibility of seeing this trend continue.
Determine if the dividend is safe using the payout ratio. This is the ratio that represents the percentage that is paid out in the form of a dividend. Lets say that the payout ratio for a company is 50%; that means that half the earnings are being paid out to shareholders, while the rest is being reinvested into business for the sake of further growth.
Are Stock Dividends Taxed?
The answer to this question is it depends on where the shares are held.
If you own the shares in a retirement account such as a 401(k) or investment retirement account, then no taxes would be incurred. The one exception is if the shares are owned on a foreign trading exchange, depending on the rules of that country’s government.
If you hold the shares in a regular investment account, then there will be taxes on the dividends received. The tax rate will be based on a few things, such as your income level, whether they are qualified or non-qualified dividends, and the type of investment product (common shares, preferred shares, debt products, etc.).