Dividend Paying Stocks: What I've Learned

As stated before, dividends are paid out of a company's earnings. To pay them, the company must first have the money. After that, it's up to the company's board of directors to decide if, when and how much dividend is to be paid. More often than not, dividends are paid in cash-although they may be paid in the form of additional stock. And, they are usually paid on a quarterly basis, or once every three months.

THE DIVIDEND ENVIRONMENT ON WALL STREET

Dividend yields have been falling for the past ten years on Wall Street. One reason for the lower dividend yields revolves around the way today's corporate executives are managing their business.

Years ago, maintaining-if not increasing-a company's dividend was very much in vague. That strategy was one way a company could tell its shareholders that it was prospering and doing well. Today management doesn't necessarily talk that same language. Instead, many firms have decided to buy back shares of their company's outstanding stock rather than pay a dividend or increase what they are paying.

While stock buybacks often result in the per share price of the stock rising, it doesn't allow for any cash to flow to shareholders-unless, of course, the shareholders sell some of the shares they own, or they own shares of the company's preferred stock. In which case the dividends must be paid.

• Where to get cash: If an individual absolutely needs income, they should consider purchasing preferred stock rather than common stock. The big advantage is that a company must pay dividends to its preferred shareholders before it pays its common stock shareholders. Another plus is that the dividend on preferred stocks won't fluctuate as on common stock, because the dividend is fixed and investors know how much their preferred stock investment will pay them. On the other hand, don't look for dividend increases on preferred stock.

TAXES AND DIVIDENDS

If a company pays its dividend in stock, depending upon the number of shares a person owns, the dividend may come in full or fractional shares. Don't be concerned about those fractional shares; over time, fractional shares add up to full ones and will increase the total number of shares a person owns of the company.

Another benefit to receiving a company's dividend payment in the form of stock rather than cash is taxes. Stock dividends aren't taxed when you receive them. The only time you'll ever pay taxes on any shares of stock you own-dividend-paying or otherwise-is when you sell those shares of stock at a higher price than what your cost basis on that stock is. (A cost basis is the per-share price paid for a security that includes commission costs). That means you control when a capital gains tax-which you pay when you sell your stock for more than you paid for it-is paid.

However, when a company decides to pay its dividends in cash you have to pay a tax on those dividends the year you receive them.

FOUR TERMS TO REMEMBER

Here are four terms investors of dividend-paying stocks must be familiar with:

• Declaration Date: This is the day that the company's board of directors announces to the world that A) A corporate dividend is to be paid, B) How much the dividend will be, C) The payable date, and D)The record date.
• Payable Date: This is the date that the company's dividends will be paid to all eligible shareholders.
• Record Date: To be eligible to receive a company's dividend, shareholders must own the stock by this date. For example, if an individual bought shares of XYZ corporation on May 16, and the company is paying it's dividend on May 31 to those with a record date of May 12, that person must have purchased shares of that stock on or before May 12. Buying on May 16 means they missed the current dividend payout.
• Ex-Dividend Date: The ex-dividend date is the day on which the dividend is actually deducted from the price of stock. Anyone buying stock on or after this date will not be eligible to receive a dividend payout from the company during this quarter. Ex-dividend dates aren't set by the company itself but by the National Association of Securities Dealers. However, remember that all is not lost, buying shares of stock on its ex-dividend date doesn't mean a person will miss out receiving a dividend from a company forever; it just means that they won't receive one that's been declared for the quarter.

UTILITY STOCKS AS DIVIDEND PAYERS

One popular type of stock is utility stock. Liked by investors because they provide a steady income stream, loved by brokers selling them because they can generally satisfy their clients' needs, utility stocks have often formed the foundation upon which many stock portfolios are built.

Today, however, utility stocks aren't what they used to be. In the 1990s, a utility stock isn't necessarily just a plain old-gas, electric, or telephone company play. Often these companies are large conglomerates that own all sorts of other businesses, companies, or have a hand in the telecommunications industry. Consequently, assuming that all utility stocks are alike, or that the management of each is as dedicated to increasing dividends as many once were is no longer appropriate.

However, that's not saying these stocks aren't good investments. These companies-like others- need to be researched and, like Oldsmobile, today's utility stocks aren't necessarily the ones they were years ago.

CALCULATING DIVIDEND YIELD

Figuring out a company's dividend yield is easy. All it takes is knowing the per share price paid for the stock, how much money in dollars and cents the dividend is, and the ability to divide.

For example, if Make Me Rich Corporation is selling for $50 a share, and the board of directors decides it's going to pay is common stock shareholders $2 a share in dividends, 2 divided by 50 equals .04. So, the stock is paying a dividend yield price of 4 percent.

DIVIDEND REINVESTMENT PLANS

A dividend reinvestment plan allows participating shareholders to purchase more shares of the company's stock with the dividends they are paid. These plans are one of the niftiest ways to build a stock portfolio and not invest more money than originally laid out for a persons initial shares of dividend-paying stocks. These plans are referred to as DRIPs or DRPs, and literally hundreds of companies offer them to their shareholders.

Depending on the company, or the way you decide to participate in a DRIP, it can take anywhere from the cost of one share of a company's stock to $10, $50, $100, or $1,000 to begin this investment plan.

As for the kind of money that can be made via DRIPs, according to Standard & Poor's Dictionary of Dividend Investment Plans, if a individual had invested $1,000 in Coca-Cola in 1985 reinvesting the dividends from that stock all along the way, at the end of 1995 the investment would be worth $12,680. That's an annual return of 29 percent over a 10-year period. On the other hand, a $1,000 investment into the footwear retailer Brown Group and reinvesting in dividends all along, would only be worth $745 at the end of the year 1995. That's an annual rate of return of -3 percent. As those two examples show, there's a risk in DRIP investing too.

Three easy ways to begin investing in a company's dividend reinvestment plan are:

1. Buy shares of a dividend-paying company offering a reinvestment plan as you would any other stock through your broker. Then, tell your broker you'd like to have that company's dividends reinvested, or paid to you in the form of additional shares of stock.
2. Join the National Association of Investors Corporation, (NAIC). Once all membership dues are paid, starting a DRIP program can begin with as little as one share of a company's stock.
3. Or, to research the DRIP arena on your own, look for the Standard & Poor's Dictionary of Dividend Reinvestment Plans in your library's reference section; ask your broker is his or her firm has a list showing the companies that offer dividend reinvestment plans; or contact the American Association of Individual Investors, (AAII). This Chicago-based non-profit organization has plenty of information available on DRIPs.

Works Cited:
Vujovich, Dian 10 Minute Guide to the Stock Market New York, United States of America: Murtha, 1997