Dividend Investing Explained For New Investors

Dividend is a reward paid by companies to their investors as a loyalty bonus. For investors, dividend investing promises to grow their investments with regular profit sharing by the companies.

Investors in the stock market can select either growth stocks or dividend stocks. The dividend is a reward issued by publicly-listed companies to their investors for staying invested in their shares. Regular dividend-paying company stocks are highly sought after by investors and have high prices in the market.  

Dividends create a stream of regular income for investors in addition to any growth in their portfolios. Dividend investing is buying stocks of companies that make dividend payouts. But before discussing dividend investing, let’s get the basics out of our way: what is dividend income?

What are dividends?

A dividend is a reward paid by publicly listed companies to investors for investing in their stocks. The company’s board of directors decides the rate of dividends, after receiving consent from the majority of shareholders. The company can also choose not to pay dividends and reinvest their accumulated profit for further growth. 

Companies can pay dividends in different forms – cash, bonus stocks, and assets. However, based on frequency, dividends are two major types – special and preferred dividends. 

It is worth noting that dividend announcements usually impact the company’s stock price – often accompanied by a significant increase or decrease in the stock price. 

A company’s dividend investment strategies may involve paying cash bonuses or shares to investors or reinvesting through Dividend Reinvestment Plan (DRP).

Impact of dividends on share price 

Anyone investing in stocks should understand the impact of dividends on the share price. 

Dividends don’t impact the overall value of the business. Instead, it lowers the value of the venture by the exact amount of the dividends. Since dividends, once paid, go out or get debited from the company’s account permanently. It is an irreversible expense. 

A common trend shows that a company’s share price increases immediately before the dividend announcement and trades at a premium. However, it declines by the same proportion when the dividend date is announced. Such a fall is due to a fall in demand from new investors who don’t qualify to receive dividends. Hence, they are reluctant to pay the higher price.

However, if the market stays optimistic until the ex-dividend date and increases more than the declared dividend amount, the overall stock price may increase and remain higher even after the dividend announcement.

The dates play a vital role in deciding the right time to invest in stocks. Here are some critical dates you should learn. 

  • Announcement dates:

    The company’s board of directors announce the dividend on the announcement date.

  • Ex-dividend date:

    The ex-date is one day before the record date. The stocks trade without dividend eligibility after the ex-dividend date.

  • Record date:

    It is the cut-off date when investors’ eligibility is scrutinized.  

  • Payment date:

    On the payment date, investors receive dividends in their Demat account

Benefits of dividend investing 

  • Dividends are bonuses given by companies from their earned profit to investors to stay loyal to them.
  • Dividend stocks are less volatile when compared to growth stocks; hence help improve the earnings of your portfolio without increasing market risk. 
  • Dividend stocks appeal to low-risk investors and those nearing retirement, who want to safeguard their principal amount.
  • Whether the company’s stock price goes up or down, investors will continue earning dividends as long as the company pays them.  
  • Investors can – reinvest in the same company, buy stocks of a different company, save, or spend the dividend income.

How the dividend is measured 

Having an idea of dividend calculation will help you research dividend stocks. 

The dividend ratio is a parameter used in calculating the dividend. The dividend ratio is the dividend per share divided by earnings per share. Expressed as 

Dividend ratio = Dividend Paid / Reported Net Income  

Companies that don’t pay dividends and businesses which pay out their total net income as dividends both have a 0% dividend ratio. 

Investors can easily calculate the amount a company wants to pay as a dividend using the dividend ratio. Similarly, they can calculate the retention ratio or reinvestment ratio for companies to determine the amount repurposed for reinvestment.

Dividend investing strategies 

Dividend harvesting is a common practice followed by many investors.

Dividend capturing is an investment strategy where the investor stays invested long enough to harvest the dividend. A harvester may buy more dividend stocks with the money acquired to increase their income.

However, harvesters may see a price drop after the ex-date, Lowering profit from capital growth. Secondly, the stock price can change during the holding period due to news regarding the business or sector. As a result, you may end up using your dividend income to offset the capital loss you incurred while selling the shares. Hence, most experts don’t recommend a dividend harvesting strategy.

Final words

For many investors, dividend income is a foolproof way to grow their nest egg. These stocks generate low-impact regular income that helps your money to increase. By reinvesting your dividends, you may nearly double your returns from investment over a period. However, it is crucial to note that dividend payments are not guaranteed. The company may decide not to pay dividends or reinvest to fuel growth. 

If the discussion has piqued your interest in stock investing, open a Demat account and get started.