What is a Dividend?

Dividends are payments made by a corporation to their shareholders.  There are stock dividends and cash dividends.  Stock dividends is when a corporation issues new additional shares of stock to the shareholders.  I stock dividend really doesn’t do much for you since it is increasing the number of shares outstanding.  Therefore your ownership in the company really doesn’t change.  As a dividend growth investor, the dividend that we look for is a cash dividend.  Cash dividends are where a company pays a portion of thier earnings out to shareholders via a cash payment.  You may receive these cash payments in the form of a check or some companies have an option to reinvest your dividends by purchasing more shares through a DRIP (dividend reinvestment program).

Do All Companies Pay Dividends?

While many companies choose to pay out a portion of thier profits to shareholders via a dividend, many other companies choose to retain all thier profits.  Oftentimes companies will retain thier profits rather then paying them out because they can use those earnings to help grow the company.  Companies that are growing at a fast pace typically will need all the money they can get thier hands on to reinvest back into the company.  They will be looking to continue thier growth through expansion or technological investment.

A majority of the companies that pay out a dividend are usually more established, larger blue chip companies.  They are already leaders of thier industry, have competitive advantages and because of thier size don’t have as many opportunities for expansion.  Therefore, management of these companies has decided to reward shareholders by paying out part of thier profits in the form of a dividend.

Many people may look as dividends as a gift from the company.  However this is not the case.  As a shareholder of a company, you are actually part owner.  You own a portion of the company which means that you own a portion of the assets, liabilities and earnings.  Shareholders vote in a board of directors who will then put a CEO and management in place to run the company.  In a round about way it is as if the shareholders have hired management to run the company for them.  It is managements job to decide what is the best thing to do with the company’s profits.  If management thinks that by retaining profits and growing the company it will mean more profits for the company in the future then they should do that.  If however, they don’t feel like they will be able to get much of a return on retained profits then they should pay out the profits to shareholders.  The company will do this in the form of a dividend.

Why Should I Care About Dividends?

There are many reasons shareholders may want to recieve dividends from companies they own.  Investors may want income to live off of.  If you are retired or just need more income, then dividend paying companies can provide this income.  The goal of many dividend investors is to offset thier expenses with dividend income recieved from companies that they are stock owners of.  Other investors may look for companies to pay a dividend because they believe that they can reinvest those dividends and earn a higher return on the money then management would be able to do.  Essentially the value of a stock is all the future cash payments you will recieve.  You can receive those cash payments either through dividends or capital gains upon the sale of the stock.  Many times management may not do the greatest job of reinvesting profits and you won’t see the great gains in capital gains.  Some investors thus prefer to recieve that money now as it is earned.  Along with recieving the money now in a dividend payment, you also don’t have to sell your shares of the company in order to get the value out of owning it.

Dividend Growth Stock Investing

Dividend growth investors are people who look for companies that consistently pay shareholders an annually increasing dividend.  Many companies have increased dividends every year for 50 years or more.  Dividend growth investors believe that companies that can consistently increase thier dividends year after year will prove to be great investments.  This dividend income will allow the investors to either pick up more shares of dividend growth companies or use the dividend income to live off of.  As a dividend growth investor, I always look for companies that are paying an annually increasing dividend.  I don’t want to invest in companies that don’t pay dividends.  If a company I own fails to increase thier dividend one year or if they decrease thier dividend then I believe it is time to sell.  If management has made a practice of increasing dividends year after year, but all of a sudden has decided not to increase the dividend or even worse to cut the dividend, then I believe they aren’t as confident in the future prospects of thier company.  This tells me it is sell time.

I believe that a solid investment plan will involve buying shares of dividend growth stocks throughout my lifetime, reinvesting the dividends and eventually living off the income provided me by the companies I own through dividend payments.