Become a Dividend Jedi
Use the force...
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it."
— Attributed to Albert Einstein
We receive a lot of questions from readers about the basics of investing.
Whenever I make an investment, I begin by asking myself one simple question: What is my goal?
For me personally, I want to be able to live off my investments. Whenever I tell someone this, they always say something like, “Yeah, that would be nice,” implying that it’s out of the realm of possibility. But this a very obtainable goal, something that the richest people in the world do.
So I take the approach of finding companies that will pay me to simply buy their stock, otherwise known as dividend investing.
Now, when I talk to others about investing, a vast majority a) don’t know dividends exist, b) are skeptical of dividends, or c) don’t understand the concept.
I’d like to go through some examples from real companies trading in the market today and why this style of investing can potentially add an enormous benefit to your portfolio.
Over my nearly 10 years actively investing in the stock market, I’ve found that dividend investing is the simplest yet most powerful force in the investing world, as it harnesses the power of compound interest.
After all, as Albert Einstein is rumored to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it."
Now, many investors out there want to make money as fast as possible, which involves greater risk. That’s because there’s no guarantee a stock will go up in price, ever. But if it does go up in a short amount of time and you sell for a profit, you’re dinged with a short-term capital gains tax. That might not matter if you’ve made a lot of money, but typically you want to avoid this, as it eats away your profits.
Now, while any investing involves risk, dividend investing acts as a baked-in moat for your portfolio.
So let’s focus on some common questions about dividends first and then I’ll show you how they work in action.
What Is a Dividend?
A dividend is a sum of money — typically in the form of cash — that is paid to investors who hold shares of a company for a certain length of time. You heard it right: cash. That means if you just own shares of a dividend-paying company, it will deposit cash into your account on a predetermined date. That money comes out of the company’s excess revenues or cash reserves.
Here’s where things get slightly complicated, but I promise it’s just basic arithmetic.
You’ll want to keep track of three numbers: the share price, the annual dividend per share (DPS), and the dividend yield. You can find these numbers through your brokerage or sites like Nasdaq and Finviz, but there are many other sites out there that track these numbers.
Let’s take a real-world example everyone loves to use and look at Coca-Cola (NYSE: KO). As of this writing, Coca-Cola’s share price is $62.84. It pays a yearly DPS of $1.84. Therefore, if we own one share of Coca-Cola, we’ll receive $0.46 each quarter (the annual $1.84 divided by four). If you want to calculate the annual dividend yield, you simply divide the DPS ($1.84) by the share price ($62.84), which gets you 0.029. Move the decimal over two places and you get 2.9%. So now that we know Coca-Cola pays an annual dividend of 2.9%, we can compare it with other companies in the same sector. But here’s the kicker... If you invest your dividend payment back into the stock — through what's known as a dividend reinvestment plan (DRIP) — you’ll consistently receive a higher and higher payout as the years go on and you accumulate more shares. You can set this up through your broker, and it’s typically a setting you can turn on depending on which service you use.
This cash dividend payment is most frequently paid out by companies quarterly, but some companies offer monthly payments as well. According to the World of Dividends blog, there are only 60 publicly traded companies that pay monthly dividends. The risk tends to be higher, as they don’t have a track record of consistent payments, but more on that below.
What’s the Ex-Dividend Date?
I mentioned that a company will pay out the dividend on a predetermined date. Here’s what I mean. When you buy dividend-paying stocks, it’s up to you to keep track of what’s called the ex-dividend date. Think of this as the cutoff date for getting paid. If you own shares up to the ex-dividend date, you’ll get paid for the number of shares you own. Now, this is important: If you buy shares on or after the ex-dividend date, you won’t be compensated for those shares that quarter. You will be compensated in the following quarter, but the payment amout may change.
There’s also the declaration date, which is the day the company announces its dividend payment and payment date. So join Outsider Club today for FREE. You'll learn how to take control of your finances, manage your own investments, and beat "the system" on your own terms. Become a member today, and get our latest free report: "World Economic Collapse: Grow Your Wealth in A Bear Market Epidemic" After getting your report, you’ll begin receiving the Outsider Club e-Letter, delivered to your inbox daily.
So join Outsider Club today for FREE. You'll learn how to take control of your finances, manage your own investments, and beat "the system" on your own terms. Become a member today, and get our latest free report: "World Economic Collapse: Grow Your Wealth in A Bear Market Epidemic"
After getting your report, you’ll begin receiving the Outsider Club e-Letter, delivered to your inbox daily.
Risks and Drawbacks?
Some investors argue that taking on risk by waiting for the dividend payment doesn’t outweigh just taking the profits if the stock goes up. This is a valid point, and one to consider as you journey through the world of dividends. But, as mentioned above, compound interest is the most powerful force in the universe, so if you want to become a dividend Jedi, you must use the force and reinvest.
Another risk is that sometimes a company won’t have enough money to pay the dividend to shareholders and will have to use debt to make the payment or cut its dividend, which will negatively affect the share price.
Benefits and Strategies
Buying dividend-paying stocks allows you to play different sectors of the economy and get rewarded in the process. You feel like you’re an employee of the company without ever having to do any work. This is the real beauty of the stock market. Dividends allow you to slowly build up equity in a company. If you don’t have a lot of cash to throw into stocks, you can start small and let compound interest do its magic. Now, there are three main strategies for buying dividend-paying stocks...
First, you can buy and hold companies that raise their dividend every year and set up a DRIP to reinvest the dividends. There’s a group of companies called the “dividend aristocrats” that have paid and increased their dividend for 25 years in a row. These companies include AT&T (NYSE: T), Exxon Mobil (NYSE: XOM), and IBM (NYSE: IBM). There are also the “dividend kings,” which are companies that have paid and raised their dividend the last 50 years! Companies like Coca-Cola (NYSE: KO), Walmart (NYSE: WMT), and Altria (NYSE: MO) are on that list.
Second, you can wait until the day before the ex-dividend date and purchase shares. This can be a quick way to get paid for owning shares without taking on the risk of holding the stock for an extended amount of time. However, a company’s share price will often go down on or after the ex-dividend date, as investors will sell their shares to take risk off the table but still be rewarded with a dividend payment for owning shares before the ex-dividend date. It’s a bit of a sneaky strategy.
Finally, you don’t have to reinvest the dividends. You can simply take the cash payment in your brokerage account and keep it for a rainy day.
Keep in mind that there are tax implications for dividends, and I’m not a tax professional, so you’d want to consult one if you have questions or concerns.
Let’s go back to our Coca-Cola example. Here’s a snapshot from the Nasdaq of roughly the last two years’ worth of dividends:
You can see that the company’s raised its dividend payment each year. On top of that, in the same time period, Coca-Cola’s underlying share price has increased nearly 17%.
It’s probably why it’s a top pick for Warren Buffett. In terms of a dividend yield, Coca-Cola’s is small. But you get the added benefit of less risk.
Now let’s look at a high dividend-paying stock.
Here are the dividends from Petrobras (NYSE: PBR), a Brazilian oil and gas company:
You can see the payments haven’t been consistent and the dividend has even been cut twice. But the stock price has actually gone up 25% in the that same time frame.
Finally, let’s look at another high-paying dividend stock with more risk.
The following are dividend payments from Israeli-based Zim Integrated Shipping Services (NYSE: ZIM):
You can see the inconsistencies and cuts here but also the massive payments. If you had 1,000 shares before the ex-dividend date in March, you’d have received a whopping $17,000 in that quarter alone. However, you’d have lost your shirt on the underlying stock, as it dropped 60% in that same time frame.
To limit risk even further, there are exchange-traded funds (ETFs) and indexes that track high dividend-paying companies. There are only a handful, but the most popular include the ProShares S&P 500 Dividend Aristocrats ETF (BATS: NOBL) and the First Trust S&P International Dividend Aristocrats ETF (NASDAQ: FID). The drawback is that you’ll only get the average dividend from all the underlying companies, so you limit your upside potential.
Hopefully this gives you a basic working knowledge of dividends and how you can use them in your own investments.
Again, none of these are recommendations, and if you collect dividends you’ll need to speak to a tax professional when tax season rolls around.
But you can see how dividends can act as a moat around your wealth fortress...
A shelter from any storm that may be brewing.
Stay frosty, Alexander Boulden After Alexander’s passion for economics and investing drew him to one of the largest financial publishers in the world, where he rubbed elbows with former Chicago Board Options Exchange floor traders, Wall Street hedge fund managers, and International Monetary Fund analysts, he decided to take up the pen and guide others through this new age of investing. Check out his editor's page here. Want to hear more from Alexander? Sign up to receive emails directly from him ranging from market commentaries to opportunities that he has his eye on.
Editor, Outsider Club
After Alexander’s passion for economics and investing drew him to one of the largest financial publishers in the world, where he rubbed elbows with former Chicago Board Options Exchange floor traders, Wall Street hedge fund managers, and International Monetary Fund analysts, he decided to take up the pen and guide others through this new age of investing. Check out his editor's page here.
Want to hear more from Alexander? Sign up to receive emails directly from him ranging from market commentaries to opportunities that he has his eye on.
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