By elmads

Both traders and investors who invest in the stock market gain money via two ways, by price appreciation (when the price you bought goes up) and through dividends (when a company gives a portion of their earnings to their investors/shareholders).

Traders mostly focus on price appreciation than dividends, while most investors focus on both dividends and price appreciation, and there are few investors who mainly focus on dividends. They are the ones who utilize the dividend investing strategy. I have discussed this in my blog titled “Popular Investing Strategies”.

People mainly focus on the income that they can get form companies through dividends, but what is a dividend? why some companies pay dividends while other do not? is paying a large sum of dividends healthy for companies? In this blog we will go into a deeper dive to the world of dividends.

Dividends are not free money

Dividends are loved by investors because of the free money it gives back to them. Well that’s what uninformed investors think of, technically speaking yes investors receive money but that is not actually free. When dividends are paid out, the stock market price falls a bit. You heard me right, the amount of money that they will give is deducted based on the stock market price. That is why it is not free, because the market price will fall based on the amount of dividends the company will pay and it is computed as dividends per share.

As an example, let’s say a company will pay a dividend worth $15 Billion for the whole year, to all of its recorded shareholders. The company’s current Total Shares Outstanding is 7 Billion.

Dividend Per Share (DPS) = Dividend amount in currency / Total Shares Outstanding

in the case of our example above;

DPS = $15 Billion / 7 Billion shares outstanding

Dividend Per Share = $2.14

This amount will be deducted on the stock market price during the specified payment date of the Ex-Dividend Date, which is the date the company disclose and decides as well. For example purposes, let’s say that the current stock price of this company is at $500 per share.

This means that the company will drop to $497.86 per share, regardless if investors or traders are buying or selling the company stock price.

Formula: $500 price per share – $2.14 dividend per share = $497.86 will be stock price.

Ex-Dividend Date is the date where the value of the dividends are removed by the exchange to compensate the amount of dividends the company will be giving to their shareholders. Dividends are not a creation of wealth, it is the transfer of wealth.

So, basically dividend paying companies give parts of the value of their company to shareholders. It is the transfer of cash to their company account to investors account

• Advantage – We get regular income and additional buying power.

• Disadvantage – We get taxed from the dividends paid to us, but we still retain the number of shares we have from the company we are invested. Not unlike when we sell it, we completely deduct the number of shares we hold from the company.

Dividends are based from company earnings

The amount of dividends that a company can pay to its shareholders are mostly tied to their profitability. Just imagine this on an individual level, if we did not receive any salary for this month, how will we pay for our bills then? this is the same question for companies.

Nevertheless, there are two other ways in which companies can pay dividends even with negative earnings in a specific year.

Firstly, through using their saved and accumulated cash from previous years. Just like with us individuals, as long as we have saved money to survive more than a month, then not receiving a salary for a month will not be of a significant problem for us.

Secondly, by acquiring debt and giving that additional loaned money boost to the company’s shareholders, as dividends. I do not fully agree with this method most especially when a company doesn’t have any earnings for that year or worse consecutive years. There are companies who do this, and for what reason? to make investors happy, in order for the investors to continue to hold the shares and not sell it.

Just think of it like this, we did not receive any salary for this month. So, we acquired debt and used that money to give it to others. Why? mostly just to please the people we gave the money to, even if we ourselves is already in a dire situation.

I do understand that companies need to think of their investors and spur loyalty, by incentivizing shareholders to continuously hold the shares for a very long time, or for investors to buy more shares of the company. Both, will be good for everyone’s sake because the stock price will less likely plunge into lower levels and most especially the price will appreciate if buying spree continues.

Nonetheless, sometimes the company’s growth and stability is more important than appeasing the investors. Let me explain;

A company who has a good and growing operations will have a stable and increasing profitability. Even if the company never pays dividends as long as the company is doing better yearly, over a decade, over a few decades or even centuries, for sure investors will always hold the shares of that company no matter what.

See for example Amazon, they’ve never given dividends to their shareholders since their Initial Public Offering in 1997. Does that mean no one is holding their company shares? Almost all investors in the world are willing to hold Amazon’s shares, to the extent that their market price is in sky high levels already. Why is that you say? that is because Amazon is continuously improving, researching and developing new products and services that can further propel their company into newer markets and greater heights. Investors will always hold companies that grows even without them paying any dividends at all.

Below is the similarities of decision making of a company giving dividends and an individual giving monetary support.

Dividends Key Dates

Investors need to know about the key dates because it dictates when we should buy the company shares in order for us to receive the dividend payment.

• Declaration Date – It is the date where the company’s board of directors announce the next dividend payment. This includes the amount of money to be given as dividends, the Ex-Dividend Date and the Payment Date
• Record Date – As the name implies, it is the record which shows the shareholders of the company. The shareholders who are in the list will be the one receiving the dividends when the payment date arrives.
• Ex-Dividend Date – This is the date where the company stock is trading already without the dividend per share amount of the dividends that will be paid. For instance, if the dividend per share is $1.5 and the company stock price is 150, then upon Ex-Dividend Date the stock price will initially drop to 148.5 because the company will get the dividend they will pay to shareholders from the company stock price.
• Payment Date – An investor’s PAY DAY!! The date where investors receive their dividend income via their investment account brokerages.

THINGS TO REMEMBER about the key dates

• It takes roughly 3 business days before a company will be able to register the new investors who recently bought the company shares, in their record books.
• If you invest in the same day as the Ex-Dividend Date, then you’ll not be getting any dividends on the Payment date. That’s because the company deducts the Dividend per share in the stock price in that specific date.
• For an investor to be included in the RECORD DATE of the company, they need to purchase the shares of the company ONE BUSINESS DAY before the EX-DIVIDEND DATE.
• Ex-Dividend Date is usually one day before the Record Date

Dividends depending on the company’s life cycle

Corporations have their own life cycles, which are the Introduction, Growth, Maturity, Decline and possible life cycle extension.

As dividends are portion of the earnings of a company, some companies will not be able to give dividends to their shareholders depending on what stage the company is currently at in the cycle.

• Introduction and Growth Stages – These stages are also known as the infancy stages of companies, in which they are being funded through capital support from large institutional investors and also the angel investors. Their earnings are mostly negative for a couple of years and are at a higher chance to go into bankruptcy if they mismanage their business operations and the capital of the company. That description alone already gives away the answer to the question if dividends is still viable in this stage, and the answer is an absolute no!

The company’s focus in here is to grow and make their operations sustainable by attaining consistent positive net income. That is only achieved through reinvestments of all of the cash flow they receive within their business, everything comes back and nothing goes out. By doing so, the profitability of an infant company will eventually come as long as they handle everything smoothly in terms of operations and capital allocation, despite the possible setbacks and failures. That is why, dividends are a big No No for most companies in this stage. Plus young companies do not take debt as well.

So that’s a no dividend payment and debt for them.

• Maturity and Decline – As the name implies, Companies who have reached this level do not expect further or gigantic growth in their profitability anymore as they have reached their maximum speed to grow already. This is the reason why companies that are matured give their excess profit to their shareholders as they do no require the surplus capital to be reinvested back to their businesses anymore. Popular mature industries that usually give hefty sum of dividends are the utility, telecommunications, oil & gas and mining companies. Most mature companies in these industries have reached their peak growth levels and are unlikely to grow exponentially anymore, unlike technological companies.

And comes the last stage, the Decline. These are the companies that are having reduced sales but with still constant costs that they need to pay for their day to day operations, hence reducing profits. Sometimes there are declining companies that are still increasing their dividend payments, which is just to make their shareholders happy. On the other hand, not all declining companies eventually pass away, because some are able to extend their life by expanding into another or newer markets.

For example, AT&T is a telecommunications company who has been in the mature stage for a long time, while some investors consider it as a declining company. Yet, this company is expanding their income portfolio by entering into the streaming services market, this is for the hope that the other revenues will grant further growth in their profits.

To sum it up

Dividend investing is absolutely brilliant, because it gives continuous cash flow in a yearly, bi-annually or quarterly basis. That is only if, the dividend paying company we have invested has good fundamentals. If it has, then it can signify a higher chance for that company to continuously pay dividends with increasing amount paid to its investors annually.

By studying a company’s business operations, decisions and reinvestments, it will give us a better view of the company’s further outlook in the future. A management who is into growing the company will always be better than a management who just wants the perks of being in a company. External factors could affect a company’s growth and expansion such as politics, economy, competition and more, but that will always be mitigated when a company has a competent and good management.

Investing in companies that pay or do not pay dividends is a personal investor’s choice. Dividends doesn’t reflect a company’s performance and greatness, because just like what I’ve told you, they can still pay it even without having good earnings. What matters in investing is for us to find which one will suit our own personality, lifestyle and time, including the one that will bring us faster yet safer to our financial goals.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.