What are Dividends?
There are advantages and disadvantages relative to investing in stocks with dividends vs stocks without dividends. Dividends are periodic payments made by companies to owners of its stock. They are a means for a company to share some of its revenue with those who own an equity interest in the company. Dividends are beneficial to shareholders because they represent additional return on investments. They are often viewed by investors as similar to interest earned on bonds. Dividend payments are part of the total return on investment in a stock that an investor receives.
Most companies that regularly issue dividends do so quarterly (four times each year). A dividend is paid per stock share. For example, if an individual owns 20 shares of stock in a company that pays $4 in dividends per year, then they receive $80 in dividend payments each year (20 shares x $4 per share = $80).
- Dividends are one way of paying shareholders a return on their investment; the payments may be done through cash, additional shares in the company, or the opportunity to buy additional shares at a discount.
- Companies that offer dividends provide investors with a regular income as the stock price moves up and down in the market.
- Companies that don’t offer dividends are typically reinvesting revenues into the growth of the company itself, which can eventually lead to greater increases in share price and value for investors.
How Do Dividends Work?
Companies typically send dividend payments to the brokerage accounts of their shareholders. Alternatively, a company may not pay a cash dividend, but instead offer additional shares of stock to shareholders.
One option with dividends is a dividend reinvestment program – DRIP for short – which allows shareholders to automatically reinvest their dividend earnings into purchasing more shares. Shareholders often obtain an extra benefit due to the fact that DRIPs enable them to purchase the additional shares at a discounted price and/or commission-free.
Each company’s dividend options – if they offer dividends – are different. However, it is always the case that a company’s board of directors must approve each dividend payment. Once approved, the company notifies shareholders about the date when the dividend will be paid, how much the dividend is, and what the ex-dividend date is (the date that determines shareholder eligibility for the dividend payment).
The ex-dividend date is of critical importance to investors because it specifies when a shareholder must own a stock in order to receive the dividend payment. If an investor fails to purchase stock shares by the ex-dividend date, he will not be eligible for the dividend payment. If, however, an investor sells the stock once the ex-dividend date’s passed, but before the dividend is actually paid, they are still entitled to receive the dividend payment because they owned the stock before and on the ex-dividend date.
Investing in Stocks that Offer Dividends
Clearly, investing in stocks with dividends is beneficial to shareholders. This is because investors are able to receive a regular income from their equity investment while continuing to hold the stock to profit further from appreciation in the share price. Dividends are money in hand while the stocks rise and fall in the market.
Companies with a record of making regular dividend payments, year after year, tend to be managed more efficiently, as the company is aware that they need to provide their investors with cash four times per year. Companies that have a long track record of making dividend payments are usually large-cap, well-established firms (e.g., General Electric). Their stock prices may not offer huge percentage gains that may be seen in the stock prices of younger companies but tend to be stable and provide steady returns on investment over time.
Investing in Stocks without Dividends
So, why would anyone want to invest in a company that doesn’t pay dividends? In fact, there can be significant positives to investing in stocks without dividends. Companies that don’t pay dividends on stocks are typically reinvesting the money that might otherwise go to dividend payments into the expansion and overall growth of the company. This means that, over time, their share prices are likely to appreciate in value. When it comes time for the investor to sell his shares, he may well see a higher rate of return on his investment than he would have achieved from investing in a dividend-paying stock.
Companies that don’t offer dividends also sometimes invest potential dividend payment cash into something known as a “share buyback” in the open market. If there are fewer shares available in the open market, then the company’s earnings per share (EPS) – theoretically – will rise. Share buybacks, by reducing the total number of outstanding shares in the market, also increase the equity percentage that each shareholder owns.
As a simple example, consider a company with a total of 200 shares outstanding. They do a share buyback of 100 shares so that there are then only 100 shares outstanding. A shareholder who owns 10 shares would then own a 10% equity interest in the company, whereas, before the buyback, their 10 shares represented only a 5% equity interest.
Where to Invest?-Stocks with Dividends vs Stocks without Dividends
There are relative advantages and disadvantages to investing in dividend-paying stocks versus stocks that don’t pay dividends. As already noted, most regular dividend payers are large, established companies that aren’t likely to go out of business. Over time, their returns may typically be relied on to closely match the overall market performance. They usually hold up better in bear markets than non-dividend-paying stocks and are commonly subject to less volatility.
However, an investor who only buys dividend-paying stocks may fall a bit short in terms of achieving a well-diversified portfolio, and to that extent, may be exposed to more risk. Investing in dividend stocks alone may mean missing out on potentially high returns on investment that come from technology and biomedicine companies that typically don’t pay dividends at all, preferring to reinvest earnings in research and development of new products.
In the end, the question of whether to be investing in dividend stocks or non-dividend stocks is best answered by considering your individual financial goals and planning and your overall investment strategy, taking into account factors such as your risk tolerance. If you do want to aim for establishing a solid stream of dividend income, several investment companies offer ETFs and mutual funds that are focused on investing solely in companies with a history of distributing large dividends.
However, your ideal stock portfolio may well offer a mix of some companies that pay dividends and some that don’t. And that may be the best approach to take: that is, focusing on putting together a portfolio of stocks of companies that you consider a good investment, regardless of the company’s current stance on paying dividends (which, after all, is subject to change at any time).
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