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Dividends: What are they? And how can investors find dividend paying stocks?
Ruby Layram
29th Aug 2024
Dividend payments are a way for investors to possibly earn passive income. But how do dividends work? And how can investors find dividend-paying stocks?
In this article we’re going to take a closer look at dividends. Keep on reading for all of the info, or click on the links below to head straight to a specific section…
What are dividends?
Investors have two ways of investing in stocks & shares: through capital gains (the amount an investment usually rises by), and via dividends.
Dividends payments are made to shareholders as a portion of a company’s profits.
Dividends aren’t guaranteed, and some companies don’t pay them at all. Instead, some firms might choose to reinvest all of their profits back into their business. (Amazon is a famous example of a firm that doesn’t ‘do’ dividends).
Other firms might pay dividends, but the amount they pay may fluctuate depending on their financial performance and/or strategic priorities. For example, if a company experiences a downturn in earnings, it may decide to reduce, or even suspend dividend payments to conserve cash.
On the other hand, if a company performs well then it may choose to increase dividend payments as a way to reward shareholders and attract more investors.
Because of how they work, dividends could be considered as a way for investors to potentially earn passive income.
Earning dividends from a fund:
It’s worth knowing that you don’t need to own individual stocks to benefit from dividend payments.
If you invest in a mutual fund or exchange-traded fund (ETF), then the fund itself may hold a portfolio of stocks, bonds, or other assets that selected and screened by their dividend yield and growth potential.
For example, say you invest in an ETF that holds a portfolio of dividend-paying stocks. The dividends received from these stocks would be collected by the fund and then distributed to investors.
Depending on the type of fund, these dividends might be paid out in cash (income dividends) or reinvested back into the fund (accumulation dividends).
How often are dividends paid to investors?
The frequency of dividend payments, if any, can vary. For many publicly traded companies, dividends are typically paid on a quarterly basis, although semi-annual or annual dividend payments aren’t unheard of.
The decision on the frequency of dividend payments ultimately lies with a company’s board of directors and may be influenced by factors such as earnings performance, cash flow, and prospects for growth.
How can investors find dividend-paying stocks?
While there are no guarantees, one way of identifying stocks likely to pay dividends is to look for companies with a history of sharing the spoils with investors.
The Dividend Champions website lists a number of firms that have a track record of issuing dividends to shareholders.
Another way of increasing your chances of finding dividend-paying stocks is to invest in blue-chips. Again with no guarantees, blue-chip companies have proven, sustainable business models which means they might be considered from the investors. The Blue Chip List provides a list of blue chips that have earned themselves a reputation for issuing high dividends.
Investing through dividend ETFs
Another way of investing in dividend stocks is to invest in dividend-paying ETFs.
A dividend ETF is a fund that holds stocks that have a history of paying out dividends to investors. Although the stocks in these ETFs can still change their dividend payments, investing through a fund will allow you to diversify your portfolio – increasing your chances of investing in a dividend-paying stock!
When you invest in a dividend ETF, the dividends are paid to the ETF issuers and then paid out to shareholders. You can also choose to reinvest the dividend payments when they are made. Payments are not guaranteed.
The dividend ‘payout ratio’
When evaluating dividend-paying stocks, normally investors look at a firm’s dividend ‘payout ratio’.
This ratio indicates the proportion of a company’s earnings that is paid out to shareholders as dividends.
A lower dividend payout ratio suggests a company retains more of its earnings for reinvestment which isn’t necessarily a bad thing. A higher payout ratio indicates a larger portion of a company’s earnings is distributed to shareholders.
The dividend payout ratio can be calculated by dividing a firm’s dividends per share by its earnings per share. For example, if a company pays out £2 in dividends per share and has a net income of £4 per share, the dividend payout ratio would be 50% (£2 dividend / £4 net income).
Do bear in mind that while a high dividend payout ratio may be attractive at first glance, if a company pays out a large portion of its earnings as dividends, then this leaves less capital available to be reinvested back into the business. This is why the higher the dividend payout ratio, the more dependent the dividend will be upon the company making a decent profit in future.
How to buy shares and earn dividends
If you’re looking to invest in this area – whether you want to buy individual shares or invest through an ETF – you’ll first need to find a suitable brokerage account.
Do also bear in mind that a diversified portfolio can thrive with or without dividend payments, and income earned from capital gains is arguably just as important as pocketing dividends.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.
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