Today I’m going to share what dividend investing is, general rules of dividend investing, how dividends are taxed and most importantly how to calculate a dividend payout.
When I started learning about investing, the term ‘dividend investing’ was thrown around quite a bit on ‘how to’ YouTube videos. No matter how many of these videos I watch, I just couldn’t grasp the full understanding.
I may not explain it the most technical way, but I’m going to share my understanding in a simple “Kelly” way. It’s my hope that you are able to come away from this article with a better understanding of what dividend investing is and be less confused than I was at the start of my investing journey.
What Is Dividend Investing:
According to Investopedia, dividend investing is, “A dividend is the distribution of a portion of the company’s earnings, decided and managed by the company’s board of directors, and paid to a class of its shareholders.”
The best dividend payers are established, in-it-for-the-long-haul companies. Think companies that are based in oil and gas, banks and financial institutions, heath and pharmaceuticals and utilities. “These companies tend to issue regular dividends because they seek to maximize shareholder wealth in ways aside from normal growth.”
In other words, dividend investing is great for beginner investors because it gives two potential sources of profit: The first from regular dividend payments and the second from the capital appreciation over time.
Buying dividend stocks can be a great way to build wealth by reinvesting your dividends earnings or generating income through your dividend earnings.
Why is this type of investing important:
Dividend investing is a safe and reliable form of investing, so for the risk averse investor, this is a perfect type of investment.
According to long-term data, dividends have historically shown growth even during recessions and dips in the stock market. “While an overall downmarket generally drags down stocks across the board, dividend-paying stocks usually suffer significantly less decline in value than non dividend-paying stocks.”
As we’re facing a recession due to world events in early 2020, dividend investing will more than likely increase and become favorable among investors because of this reason.
Finally, “Over the past 93 years dividend stocks traded on the S&P 500 have provided investors returns close to twice those of stocks without dividends.”
Dividends are important because they reduce risk, they give diversification to an investment portfolio and they are easy to understand for even the most beginner investors.
General rules on dividend investing:
1. Don’t rely only on dividends
As with anything in life, don’t put all of your eggs in one basket. The same goes with investing and especially with dividend investing. Dividend investing is a part of your portfolio, not your entire portfolio, so do not– I repeat, do not rely on dividends for your income.
2. Always reinvest your dividends
Since you aren’t relying on dividends to live, it is wise to reinvest the money made. This way, you make even more money and are constantly in the ‘investing game.’
Now I’m sure you are wondering how you get these dividend payouts. Do they just go back to your bank account? Do you get a check in the mail?
Dividend payouts actually get put into your “buying power” or account.
As you can see here, I have a buying power of $0.24, that is from a dividend payout that I’ve received since the last stock purchase.
3. Be cautious of high yield payouts
If a company is paying out more than they are earning, it’s a giant red flag. Avoid high yield payouts and instead opt for more realistic payouts. Typically a 4-6% payout is considered very good, anything over that raises some eyebrows.
4. What to look for when buying a new dividend stock:
There is so much to consider when you are looking to buy new stock. You need to know the revenue of the company, see if the company is growing over time, check if their earnings are consistently growing over time and look into how much debt the company is in.
How are dividends taxed:
Dividends are taxed in two different ways depending on what type of dividend they are. Ordinary dividends, or the most common type of dividend, are usually paid out from the earnings of a corporation. These dividends are taxes as ‘normal’ income.
Terms you will hear in dividend investing and what each one means:
• Dividend yield: The ratio of a company’s annual dividend compared to its share price. The dividend yield is represented as a percentage and is calculated as follows:
• Payout ratio: The ratio of the total amount of dividends paid out to shareholders relative to the net income of the company. It is the percentage of earnings paid to shareholders in dividends. The amount that is not paid to shareholders is retained by the company to pay off debt or to reinvest in core operations.
• Cash payout ratio: A financial metric showing the proportion of earnings a company pays shareholders in the form of dividends, expressed as a percentage of the company’s total earnings. On some occasions, the payout ratio refers to the dividends paid out as a percentage of a company’s cash flow.
• P/E radio: The price-to-earnings ratio
• EPS: Earnings Per Share
How to calculate a dividend payout:
To calculate dividends, find out the company’s dividend per share (DPS), which is the amount paid to every investor for each share of stock they hold. Next, multiply the DPS by the number of shares you hold in the company’s stock to determine approximately what your total payout will be.
This number will give you a yearly dividend total, some dividends are paid out yearly and some are quarterly, to calculate the quarterly number, divide that number by 4.
As of 4/10/2020 AT&T (T) is trading at $30.70 and has a dividend yield of 6.96.
$30.70 X 0.0696 = $2.13 per year.
I have 5 shares of (T), so I will multiply that number by 5.
$2.13 X 5 = $10.68 per year.
(T) pays quarterly dividends so we will divide that number by 4.
$10.68 / 4 = $2.67 per quarter dividend payout.
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