Dividend Investing Basics

Dividends are cash payments that companies make to shareholders, representing a share of profits. For many investors, dividends provide income and signal financial health. [DEFINITION] Dividend: A distribution of a portion of a company's earnings to shareholders, typically paid quarterly. ### How Dividends Work When a company is profitable, it can: 1. Reinvest in the business (growth) 2. Pay down debt 3. Buy back shares 4. Pay dividends to shareholders [EXAMPLE] You own 100 shares of Johnson & Johnson (JNJ). JNJ pays a quarterly dividend of $1.24 per share. - Quarterly payment: 100 × $1.24 = $124 - Annual payment: $124 × 4 = $496 ### Key Dividend Metrics **Dividend Yield** [FORMULA] Dividend Yield = Annual Dividend ÷ Stock Price × 100 [EXAMPLE] JNJ pays $4.96 annual dividend, stock is $160. Yield = $4.96 ÷ $160 = 3.1% **Payout Ratio** [FORMULA] Payout Ratio = Dividends Per Share ÷ Earnings Per Share × 100 Shows what percentage of earnings goes to dividends. | Payout Ratio | Interpretation | |--------------|----------------| | Under 30% | Conservative, room to grow | | 30-50% | Healthy balance | | 50-70% | Moderate, less flexibility | | Over 80% | Risky, limited cushion | [TIP] A payout ratio over 100% means the company is paying out more than it earns—unsustainable without cutting the dividend. ### Dividend Aristocrats [DEFINITION] Dividend Aristocrat: An S&P 500 company that has increased its dividend for 25+ consecutive years. **Examples of Aristocrats:** - Coca-Cola (KO): 62+ years - Johnson & Johnson (JNJ): 62+ years - Procter & Gamble (PG): 68+ years - 3M (MMM): 66+ years [KEY] Dividend Aristocrats have proven they can grow dividends through recessions, wars, and market crashes. This track record suggests financial resilience. ### Important Dividend Dates **Declaration Date:** When company announces the dividend **Ex-Dividend Date:** First day the stock trades without the dividend. Buy BEFORE this date to receive the dividend. **Record Date:** Date you must be a shareholder to receive payment **Payment Date:** When dividend is deposited in your account [WARNING] Stocks typically drop by approximately the dividend amount on the ex-dividend date. You can't profit just by buying before and selling after—the drop offsets the dividend. ### Dividend Growth Investing Rather than chasing high yields, focus on dividend GROWTH: [EXAMPLE] Company A vs. Company B | Start | Company A | Company B | |-------|-----------|-----------| | Yield | 4.0% | 2.0% | | Growth | 3% annual | 10% annual | | Year 10 Yield on Cost | 5.2% | 5.2% | | Year 20 Yield on Cost | 7.0% | 13.5% | Company B's lower starting yield grows into a much higher income stream. ### Dividend Reinvestment (DRIP) [DEFINITION] DRIP: Dividend Reinvestment Plan—automatically using dividends to purchase more shares. Benefits: - Compound growth accelerates - Dollar-cost averaging - Usually no commission - Fractional shares possible [EXAMPLE] You invest $10,000 in a stock yielding 3%. Without DRIP: $300/year in cash. With DRIP: Those $300 buy more shares, which pay more dividends, which buy more shares... After 30 years at 8% total return: - Without DRIP: ~$50,000 - With DRIP: ~$100,000+ ### High Yield Warning Signs [WARNING] Very high yields (8%+) often signal problems: - Stock price has crashed (yield rose as price fell) - Dividend may be cut - Company in distress - Not sustainable [EXERCISE] A stock trades at $50 and pays $2 annual dividend. The company earns $4 per share. Calculate: 1) Dividend yield, 2) Payout ratio, 3) Is the dividend sustainable? |ANSWER| 1) Yield = $2 ÷ $50 = 4%. 2) Payout ratio = $2 ÷ $4 = 50%. 3) Yes, the dividend appears sustainable—50% payout leaves room for growth and a cushion if earnings decline temporarily. [SCENARIO] You're comparing two stocks: - **Stock A:** 6% yield, payout ratio 90%, no dividend growth last 5 years - **Stock B:** 2.5% yield, payout ratio 35%, 10% annual dividend growth Stock A's high yield looks attractive but is risky—one bad year could mean a dividend cut. Stock B's growing dividend will likely exceed Stock A's payout within 10 years while being much safer. For most long-term investors, Stock B is the better choice.