Dividends: Knowing How They Work and Their Value

There are investors who undervalue or neglect the importance of dividends when it comes to stock market investing. A lot of investors tend to view these as little bonuses correlated with buying stocks.

In this article, you can uncover both the importance of dividends and how they work to help investors.

Understanding Dividends

What are dividends?

A dividend is a form of payment distributed by a company to its shareholders. It can be in the form of cash payments, shares of stock or even other properties. It is being decided by the company’s board of directors.

In simple terms, dividends are shares of an investor out of the total earnings of a company. It is one way for investors to gain profit via stock ownership.

How are dividends distributed?

Companies that usually issues dividends can choose from a wide array of methods in distributing such to its stockholders such as:

  • Stable Dividend Policy

This follows steady dividend payouts unmindful of the present corporate earnings.

  • Target Payout Ratio

This means that there is a certain measure on the size of the dividends of a company. This is usually determined through a stable dividend policy. In here, the goal of the company is to pay a specified percentage out of its earnings.

  • Constant Payout Ratio

With constant payout ratio, a company chooses a specific percentage out of its yearly earnings as dividends. Thus, dividends vary accordingly, based on earnings.

  • Residual Dividend Model

In this model, a certain company’s dividends are centered on its total earnings minus the funds required by the company to finance and run its equity portion of its capital budget. The remaining profits are the ones being paid out to shareholders.

What are the usual companies that issue dividends?

Actually, larger and established companies are the ones capable of issuing regular dividends to their shareholders. They would like to be of support as their shareholders increases their wealth. However, the same cannot apply to startup companies and those belonging to the technology or biotechnology sectors since their profits are being reinvested to carry on growth and expansion.

Looking from history and records, the following sectors and industries have been known to have the highest dividend distributed to shareholders:

  • Basic materials
  • Oil and gas
  • Banks and financial
  • Healthcare and pharmaceuticals
  • Utilities

How can dividends be advantageous?

There are several countries where investors belonging to the high marginal tax brackets invest on dividend-paying stocks to take advantage of a more favorable tax rate.

Dividends can also be a sign of a company’s health status. If a certain company normally gives dividend payouts, and is now on the verge of reducing or eliminating such, it can be a good indicator to investors that such company might be in trouble. Another one, too, is when the dividend rate becomes high suddenly; it can be a great signal that the company is performing positively in the market.

Dividend-paying stocks also have the ability to stand-out in a bear market. Hence, investors can have somewhat a good protection if they chose to invest in dividend-paying companies.

Moreover, dividends help conserve the purchasing power of capital for investors. There are usually annual income returns that can beat the effect of inflation.

Read also: 4 Dividend Stocks Investing Mistakes You Need to Avoid


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