Dividends Explained (An Exclusive Dividend Guide)

The two most popular ways to make money from your stocks are capital gains (buying at a lower price and then selling at a higher price) or dividends (The company you own paying you a portion of their profits).

What are dividends?

Dividends are payments (usually a portion of the company’s profits) made from a company to investors who own their stock.

Not all companies pay dividends, and companies are not required to pay dividends. It’s completely optional and up to the company to decide.

If a company pays dividends, it’s simply seen as an extra benefit of owning the stock. A perk, if you will.

Most dividends are typically paid quarterly (every three months).

However, companies can pay dividends as often as they want.

Some companies might pay dividends monthly, while others might pay them annually. It’s up to the company to decide how often they want to pay dividends.

If you are a long-term investor, I recommend reinvesting any dividend payments you might receive.

Reinvesting your dividends will help you grow your portfolio faster since all of the dividends you reinvest will continue to earn you more money and speed up the compounding effect.

As seen in the chart below, reinvesting your dividends can be a powerful move over the long run.

Most stock brokerages offer automatic dividend reinvesting programs (known as DRIP). Contact your stock brokerage for more information.

What is a Dividend Yield?

Company dividends are typically presented to investors as “Dividend Yield.”

A Dividend Yield is an annual percentage of the stock price paid in the form of dividends each year.

For example, let’s say a stock pays a 2.00% dividend yield, and the stock price is currently $100.

That would mean that the stock pays a $2 dividend per stock per year.

($100 * 2% = $2)

Let’s say the stock pays dividends quarterly (every three months).

You would then divide that dividend payment by 4 (since there are 12 months in a year).

($2 / 4 = $0.50)

So each stock that you own would pay $0.50 in dividends every three months.

How are dividends taxed?

You will owe taxes on the total dividend payment. Even if your dividends are reinvested.

Being paid dividends is considered a taxable event, and you will owe taxes on them.

(Unless you hold your stocks in a tax-exempt account, such as a Roth IRA, taxes on dividends don’t apply as long as you meet the account requirements.)

Most dividends are taxed as “Qualified Dividends,” which are taxed as long-term capital gains, meaning 0%, 15%, or 20%, depending on your tax bracket.

Some dividends are taxed as “Ordinary Dividends,” which are taxed as short-term capital gains (AKA earned income and up to 37%).

The best way to check if your dividends are qualified or ordinary is to go to dividend.com and look it up on their website to see how your dividends will be taxed. It will also be stated on your 1099 tax form at the end of the year if you decide to wait until then.

In recent years, stock buybacks have been a popular way for companies to reward investors instead of dividends. This is primarily due to the tax benefits behind stock buybacks.

Dividend payments are almost always taxed, whereas rising stock prices aren’t taxed until you sell.

How do stock buybacks work?

A stock buyback is when a company uses its cash to buy shares of its stock on the open market. Companies often do this to return money to investors while also providing a tax-friendly way of doing so.

Companies have Increasingly focused on offering stock buybacks over dividend increases in recent years.

How stock buybacks work is that they would set aside a chunk of money to be used to repurchase stocks from investors at the market price. Effectively raising the overall stock price since fewer stocks will be available to buy on the open market.

The main reason companies would do a stock buyback is to create value for the investors who own the stock (similar to dividends).

By purchasing back large chunks of stocks, the company helps increase the stock's price. All without causing any additional tax headaches for the investors who own the stock.

Most people who are investing long-term reinvest dividends anyways. So stock buybacks allow companies to essentially reinvest that money on behalf of investors without causing additional tax events.

Dividend Research Questions

If your personal goal is to invest in individual dividend stocks to build cash flow specifically, here are some questions you should consider before investing in a dividend stock.

Remember: These questions aren’t perfect, and they aren’t meant to be the “end all be all” to your dividend research.

But they should help you get moving in the right direction.

Just because a company offers a high dividend doesn’t necessarily mean it is a good buy.

Here are some questions to consider before investing in a company specifically for dividends.

Is the payment ratio less than 60%?

Is the dividend increasing every year?
Is the company consistently profitable?
Is the company’s industry in good health?
Is the debt-to-equity ratio less than 2?

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Dividend Funds

If you want to skip the stock-picking game, here are some of my favorite Dividend funds. These ETFs/REIT are also popular amongst many dividend investors.

As always, please do your own research before making any investment decisions.

$SPYD - (ETF) 80 high dividend-yielding companies within the S&P 500.

Div Yield: 4.75%

Dividends Paid: Quarterly (every 3 months)

$O - (REIT) 6,500 commercial real estate properties owned under long-term lease agreements.

Div Yield: 4.39%

Dividends Paid: Monthly

$SCHD - (ETF) 100 high-dividend-yielding stocks in the U.S.

Div Yield: 3.04%

Dividends Paid: Quarterly (every three months)

My Final Thoughts: Are dividends worth it?

If you’re specifically looking for dividends to build cash flow, I think investing in dividend-specific stocks is a good move.

Especially if you’re looking to play on the conservative side.

Companies that have offered consistent dividend payments for years are seen as solid and stable companies.

However, if you’re younger and looking to maximize your annual returns, you’d likely be better off focusing on investing in stocks for price appreciation rather than for dividend cash flow.

Stock appreciation, in general, has historically outperformed dividend payouts. Especially since many companies do "stock buybacks" instead of offering dividends nowadays.

So I wouldn’t specifically chase dividend yields. If the stocks you own offer dividends, cool. If not, I wouldn’t stress about it.

I would instead rather the companies I invest in use their profits to create more value for their overall business.

But that's, of course, just my personal preference. So keep that in mind.

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As Always: Buy things that pay you to own them.

-Josh

Blog Post: #022