Several conditions must be met before a stockholder is eligible to receive a dividend or distribution. Those who are not “shareholders in record” as of the date set by the Board of Directors will not receive the dividend payment. When a stock trades “ex-dividend,” it means that the dividend will not be included in the shareholder’s earnings for that day. If you acquire or sell the stock after the ex-dividend date, you will not be entitled to the current dividend payment.
Even though it goes against common sense, dividend yield decreases with a stock’s price. The dividend yield of a stock measures how much money an investor receives for each dollar they put into the stock. Inexperienced investors may incorrectly assume that a higher stock price also means a higher dividend yield. To better grasp this inverse relationship, let’s have a look at the dividend yield formula.
As a rule, dividends are distributed on a per-share basis. If you own 100 shares of ABC Corporation, you will receive $100 in dividends. Let’s say ABC Company was purchased at $100 per share. This would imply spending a total of $10,000. Due to ABC Corporation’s extraordinary profitability, the board of directors has authorized an annual cash dividend of $10 per share. After holding ABC shares for a year, you will get a $1,000 dividend payment. If the stock price is $10,000 and dividends are $1,000 each year, then the yield is 10%.
Shares of ABC Company would be purchased for $200 each. If you paid $20,000 or received just 50 shares for your initial investment of $10,000, the yield would drop to 5%. As the stock price increases, the dividend yield naturally falls.
The question of whether or not dividend-paying stocks are a solid investment in the long run is an important one. Companies that are able to consistently distribute dividends to their shareholders are usually doing well financially. Investing in reliable dividend payers is a tried and true method of building wealth. Your $10,000 investment in ABC Company will grow to $11,000 after a year. Assuming the stock price remains unchanged after a year. After reinvesting your dividends, your total investment is still worth exactly what you put into it ($9,000 in stock value).
This is why stocks that pay dividends are popular. It’s an effective method of protecting against stock market volatility, and it also provides upside potential and dividend income. The purchase of dividend-paying equities is encouraged by many prominent investors, including John Bogle and Benjamin Graham.
During the 2008–2009 economic crisis, nearly all major banks reduced or discontinued dividend distributions. These corporations have a long history of regularly rewarding shareholders with dividend payments every three months. Despite a long track record, many payouts were cut.
As a result, dividends are not assured and are instead vulnerable to external and internal factors. The fact that dividend-paying companies tend not to be industry leaders in terms of growth is a possible downside to buying their stock. High-growth firms have outperformed most stocks over the years, but they have very rarely paid out substantial dividends to shareholders. Growth firms place a premium on R&D, capital growth, and holding onto their best people. Consolidations via mergers and acquisitions also occur often. The profits made by these businesses are kept in-house and used for expansion rather than distributed as dividends to shareholders.
Extraordinarily high-yielding companies should also be avoided. As we have shown, falling stock prices can actually result in rising dividends. The dividend is a major motivating factor for many first-time stock buyers. The optimal size of a dividend payout is not established by law or consensus.
Companies in the S&P 500 index that pay dividends typically have an average dividend yield of 2–5%, depending on market conditions. Stocks with yields higher than 8% merit further investigation into their genuine state. You’ll be able to tell the difference between a company that’s truly in crisis and one that’s only momentarily out of favor, which will aid you in making a wise investment choice.