Good Day Tackle Traders, I want to answer another question that I get often with this week’s blog. I am often asked about dividends as most who know me know that I am a massive fan of getting paid to own a piece of a business. I am usually asked how I know what is a good dividend-paying stock is and what should I do with it when I own it? These are common questions and its the ones I asked before I started getting into dividend investing. So this week I am going to give an overview of the things I am looking for in a dividend payer and how I approach getting those equities. So in the immortal words of ELMER FUDD, be very very quiet we are hunting dividends!
First up, what is a dividend? Essentially a dividend is a share of the profits in relation to ownership in a company. For example, If you own shares of AAPL and they make a profit then the company can decide to reward its shareholders by giving them a slice of the profits in the form of the dividend. Each common share gets the same amount of dividend and it is announced and the beneficial owner of the stock on the ex-dividend date is the one who gets the dividend paid on the date payable which is after the ex-dividend date. There are lots of companies that pay a dividend and lots that don’t, it all comes down to the philosophy of the management of the company.
There is a multitude of ways to look at a company that pays a dividend but I think we can narrow down some of the ways by stating some truths about dividend payments and also the things I believe that a dividend payment can tell you about a company. If a company is paying a dividend then most likely they are making a profit or at least have made profits in the past, this does not guarantee they will make profits in the future and for this reason, we need to pay attention to things other than dividends to determine the fundamental health of a company, however, I believe that companies that pay consistent dividends tend to be stronger than those that don’t. Now there are exceptions to every rule and Berkshire Hathaway would be that exception as they don’t pay a dividend but are still a fundamentally healthy company.
A truth about dividends is that the bigger the dividends are typically the more volatile the stock seems to be and one could say that more risk could also be present. With dividends being a function of profits for the most part this means if profits fall then the dividend should fall as well, right? This is not necessarily the case. The companies can pay dividends from the cash they have on hand if they go through an earning slump but typically this can hurt the dividend payment in the long run as cash tends to run out if the slump is prolonged. There is a metric called the dividend payout ratio and this number as a percentage tells one how much of the earnings are going to pay the dividend. If this number is low then is it relatively easy for the company to pay the dividend and there is less fear of the dreaded dividend cut. The higher the number and the more likely as time passes the dividend could be in peril. A good case to look at would be GE. They paid solid dividends for many years and then suffered some earnings troubles and their dividend payout ratio got out of line and they eventually cut the dividend. This is where you can see trouble on the horizon if you are paying attention to the fundamentals of a company.
So when we think about dividend hunting we need to keep in mind that the dividend is a measure of health for most companies and that the dividends should be in line with the profit expectations. Also, keep in mind that chasing after high dividend payouts can spell trouble and therefore you need to have a plan about acquiring good dividend-paying stocks and giving consideration to how your overall portfolio would look once you achieve your goal of acquiring dividend-paying equities.
The first step in building a great dividend paying portfolio is to sit down and think about what you want to achieve from the portfolio. Think about the rate of return and then look into the stocks that can help you achieve this over the long run. Dividend investing is a long term focus and if you have trading skills you can enhance any dividend portfolio nicely to achieve success.
In future blogs, we will go over the other things required for dividend hunting success and then you will be ready to build your very own dividend-paying portfolio.
Coach “Old Money” Holmes
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