Pros and Cons of Investing in Dividends

First, let us start off by defining what dividends are for those who are unfamiliar with the term and interested in learning more and perhaps beginning to invest.  Dividends are the earning from corporation after-tax earnings that are distributed to its shareholders. While dividends put money in the pockets of the company’s shareholders, they are not without disadvantages.  The company pays a rate per share on a monthly, quarterly or yearly basis. Mostly companies will pay on a quarterly basis.   Disbursement of these funds can be in cash or they can be paid in the form of the company stock, which can be to your advantage and disadvantage as well. A company earns profit from operations; management can do one of two things with the profits. It can retain them and reinvest them into the company creating more profit and thus further stock appreciation and the second option is to distribute a portion of the profits to shareholders in the form of dividends.

Dividend investing can be profitable, and there are many ways to screen a company with many stock screening programs that you can pay for and some you can use for free.  Understanding the characteristics of good dividend stocks are essential, your screening process however you decide to use will help filter out unacceptable choices. Just remember, should fully understand the role of dividends and the company’s cash flow before jumping to conclusions.

The supporters of dividend payments refer of to the phrase “bird in the hand” cash. It is a philosophy that seems to work for many investors. It is the cash in hand argument with its basis being it is better to get something for holding your stock, rather than depending solely on  a rise in share price in order to earn money. The quarterly dividend put money back in the hands of its investors while they hold the stock.  Over the long term, these disbursements add up and are in addition to gains made by the future sale of share. Companies paying regular dividends often appear in lists of overall return leaders. Companies also publish their dividend announcement every quarter as well; because of the distribution of cash to share holders will holds great public relations for a paying company. 

Shareholders hold on to their shares knowing they will be receiving the dividend payment, if more investors hold the stock, the price may rise and grant more gain’s for the investor.

There is stability in these companies because investors see dividends as a sign of just that, stability. Those frequent payment of dividends to investor’s shows the company has cash flow and want to keep investors onboard. Dividends contribute to shareholder loyalty making companies less susceptible to market volatility and attract new investors.

Dividends are not misleading, companies pay dividends showing a steadily increasing dividend payout is viewed as a strong indication of a company’s continuing success. They cannot be faked, either they pay or the not paid.   There are disadvantages when investing in dividend stocks.  Unless you have invested a great deal of money into them, there will not be that much profit. Most stocks pay out a dividend of around 3% to 10% but if you want to make any kind of descent money, you will have to invest with a great deal of money. Dividends receive a double taxation when it comes to taxation.  The company pays taxes on any dividend it declares and there are also taxable to the shareholder when the dividends are distributed.  What start out as a large sum of money can turn to be a much smaller amount.

Companies also have poor public relation since they are not obligated to pay dividends to the shareholders and there may be times they decide not to declare their earnings, a good example is perhaps due to decrease in earning. Not only can this result make the shareholder very unhappy but it will give the company a very poor public image and deter potential investors.   Just because a company regularly pays out dividends it does not indicate that the company will do well in the future.

Some companies pay their dividends from available cash and some companies even pay them by taking on new debts, selling some of its assets or additional stocks.  It can make the shareholder happy for awhile but it could also be a sign that the company’s stock in not a good investment risk. Some investors feel that companies that pay large dividends mat not be all that great to invest in for the future.   One thought is that the rather than sending money to its shareholders, it should instead purchase needed items for the company, example: equipment, hiring additional employees or increase its marketing its sales and development budgets. Dividends can lessen the value of its stock in the short term because the company has less cash on hand after it issues dividends, it is seen as having less value to the investors and its shares of stock are seen as being worth less.

A common argument about dividends is the company management is spending elsewhere. There can be talk that the executives aren’t trying and are lacking incentive to return the cash to shareholders.  CEO’s can waste your money by taking on project’s that do not work out..  All too often, executives are compensated based on pre-tax earnings goals instead of per-share goal and the can misaligned executive and shareholder inters.  This is why it is essential to look up and study the company and its management of capital allocations before investing in the company.

You still have the advantage of making a steady profit without a lot of time and effort and perfect way to make some extra incoming. If you have invested in a good and strong company, you know that the company will not just stop and go under and not pay out their dividends.  This type of investing is pretty safe and a great start for beginners to become more familiar with investing. 

Last but not least here is one great way to study the characteristic of a good dividend stock is going to be the many tools to help filter the good and back dividend stocks. Make sure to focus on the Dividend Yield. The dividend yield can be calculated primarily in one of two ways , either by using the trailing 12 months dividends, or by using the expected dividends for the upcoming 12 months. Then divide that number by the current price of the stock. You will want to buy dividend stocks that have a yield that is higher than the overall market. Stock market yields as well as individual stocks yields will fluctuate over time, as stock prices move up and down, and the amount companies pay out in dividends changes, so it is good to check these factors right before you buy a stock, and not just rely on data you put together at some earlier point in time. Make sure to look for stocks with dividend yields of at least 4% to 5%.

Secondly look at the company’s profit also known as the earnings. Profits are what makes the company growth and makes the dividends pay out a lot higher payment.  One of the best and easier way to measure profitably and used frequently is the company’s return of equity or ROE. When look at the ROE the higher better.  When looking at the ROE what you will want to look for will be in the 10% to 13% range. Remember to look at the company’s profit. You may also see the company’s EPS which is the earning per share and again just remember that the higher the better!