Investing in the stock market is a dream come true. Having the ability to own portions of the very companies you love is one of the many things that make the investing so rewarding. Even though the percentage of a given company company any one of us would be buying is incredibly small, the moment you own one share you’re a partial owner of the company. It may just be me, but I love seeing the companies I own in my day to day life.
The first ever company I bought shares of was Tim Hortons (now a portion of Restaurant Brands; QSR), and ever since that day it has had a special place in my heart. I’ve watched them grow and become a part of the same corporation that owns Popeyes (another of my favorite brands) and expand across the globe.
I promise that digression is relevant for something other than making myself hungry.
I bought a company I loved, a company that I believed in, one with growth potential, and most importantly for this article: a dividend. This article is not necessarily a recommendation of Restaurant Brands, it is however a recommendation of dividends.
I’ve said that word a lot without defining it so let’s dive in a bit.
A dividend is a cash payment a corporation gives its shareholders a recognition of them holding the stock. These payments are not mandatory, except in very specific circumstances, are most often paid out quarterly. The way this works is if you were to have 10 shares stock in Company X and each quarter, they pay a dividend of $0.50 per share, you would receive $5.The only requirement here is that you hold onto the stock from before the Ex-Dividend Date (the day a company finalizes who gets the dividend payment) through the day you actually receive the dividend (the Dividend Payable Date).
Simple enough.
The thing that makes a dividend rather appealing is that this is cash being directly given out to you, which you can then use for whatever you wish. You can invest back into the company, you can save it up and invest it elsewhere, or you can buy whatever you want. This means that your return isn’t entirely determined on the stock price.
If Company X has a 2% annual dividend yield, even if the stock is flat you will have earned 2%. If Company X has a bad year, that dividend allows for a cushion, and if Company X crushes the broader market, the dividend propels it even higher.
Dividends are often a way to hedge a little bit of the risk in your portfolio. A dividend can act as a buffer in order to make your portfolio a little less susceptible to the swings of the market.
There are often a lot of misconceptions swirling around involving dividends, let’s look at some questions you may have.
- Does a company have to pay the same dividend each quarter?
No, a company may increase, decrease, or even cut entirely, a dividend at their own discretion (as long as it is outside the range from the Ex-Dividend to Dividend Payable Date). Depending on the circumstances, a dividend cut could even be the financially prudent decision. An example of this would be cutting the dividend in order to retain more employees during a Black Swan event like COVID-19.
- Coca-Cola pays a dividend, Amazon doesn’t; does this mean that Coca-Cola is the best stock pick?
Not necessarily. A common misunderstanding is when investors believe that a dividend means you will have a higher return automatically. While none of us can predict the future, many times companies will not pay dividends if they are aggressively trying to grow. If you’re a shareholder of Amazon, you may want them to take whatever they would pay as a dividend and throw it back into the company. This can sometimes lead to even larger returns than what you’d receive from a dividend.
- Dividends are tax-free, right?
NO! Unless you’re in a tax-deferred account I really hope you’re paying income tax on your dividends.
- My dividend yield was 2% yesterday, but today it’s 1.9% did they decrease it?
A common mistake is confusing a dividend amount with the dividend yield. Basically, the yield is just the dividend amount (a fixed number) divided by the stock price, (which fluctuates each day). This can lead to varying dividend yields each day, but not the dividend amount.
- I found a company with a 17% annual yield, isn’t that just the easiest way to beat the market?
Please do not fall into a dividend trap. Many investors have seen a juicy yield and havethrown good money after bad by following an ultra-risky company they do not understand. Yes, there are some companies with wildly high dividend yields. Some of these are solid companies that I actually like, but it is more the exception than it is the rule. As we know from the wonderful thing that is compound interest (Link) a 2% difference can make an incredibly large difference over decades but keep an eye out for dividends that look too good to be true. In my series on financial metrics we are going to look a little bit closer at when a dividend might just be too good to be true. In the meantime, if dividend investing sounds right to you, I recommend you take a look at our stocks page (LINK). On there you can find companies that both pay dividends and are primed for growth over the next few years.
** Disclaimer: The Tempered Bull is committed to enhancing the finance wellbeing of our readers; however, these articles should not be your only resource. The suggestions made here are meant to be taken in conjunction with professional financial assistance. We are not financial professionals, just regular people with a passion for sharing our experience. The Tempered Bull does not have any private knowledge about the companies we discuss, and The Tempered Bull and its associates do not benefit from your purchase or sale of any equites. The Tempered Bull has a disclosure policy.