Imagine having an addition paycheck coming to you every quarter. Think of it as a secondary quarterly bonus that is not tied to your employment. With stock trading this type of income stream is available to you!
As we have discussed in previous lessons, the main goal of stock trading is to buy at a lower price and sell at a higher price. This will generate profits in your account. A secondary source of profit from stocks is going to come from dividends in the companies that you are invested in. Unlike profits from buying and selling, this income is locked into place at a set rate and is paid to you on a periodic basis. In this article, I’m going to be covering the basics of dividend payments and how you make sure that you receive these payments.
What are Dividends?
Dividends are simply distributions of a company’s profits to its shareholders. Investors who buy stock are entitled to dividends only when the company’s board of directors votes to make distributions. Stockholders are automatically sent any dividends for the amount of shares they hold in their account.
When you buy a stock, you will be able to see if it pays a dividend or not and what the yield is on that dividend. When I say yield I am referring to what percentage of payout you can be expecting.
Dividend Yield= Annual Dividend/Current Market Value of the Stock
For example, looking at Microsoft we can see that it pays an annual dividend of $1.56 and it is current trading at $60.35. For that reason, the dividend yield=2.58% (1.56/60.35)
How are Dividends Paid to Shareholders?
Typically, almost all dividends are paid to shareholders quarterly unless the company stipulates otherwise. The company will decide what amount of money per share they choose to give back to shareholders. As an example, a company may decide that it’s going to issue a dividend of .25 cents per share. If you owned 100 shares, then you would receive a dividend payment of $25 dollars every quarter in which you hold the stock.
If you want to participate in the company’s dividend there is a certain date in which you have to buy the stock so that you are entitled to the dividend. The date in which you do NOT receive the next dividend payment is called the ex-date.
There are 3 dates that I want you to know to fully understand the concept of the ex-date. The first is the record date.
- The record date is the day the company declares that there will be a dividend paid on (insert date here) for the amount of (insert amount here).
- The pay date is the day that you will receive dividend payment in your account as a shareholder.
- The ex-date is TWO BUSINESS days before the record date.
Think of the ex-date like your ex-wife/husband or ex-girlfriend/boyfriend. As soon as you separate from them you are done with them completely and they are not entitled to any of your things. In order to participate in the companies dividend you have to purchase shares 1 business day before the ex-date.
Let’s take a look at an example. Microsoft declares a dividend payment of .25cents to stockholders of record on Wednesday, June 21. What is the ex-date?
If you guessed Monday, June 19th then you would be correct (2 days before record date). When would an investor have to purchase shares in order to receive the dividend?
If you guessed Friday, June 16th then you would be correct (1 business day before the ex-date).
The actual pay date of the dividend will be approximately one month away from the ex-date. You can look up what a company’s ex-date and pay date are before you invest in that company to see if you can be entitled to a dividend. If you simply buy and hold a stock these dates might not be that important to you but if you were planning on selling a stock that pays a dividend, wouldn’t you want to check to see if you could hold it for one more dividend payment?
Stock Price Reduced
So we know now that this dividend income is guaranteed to the investor. The problem lies with the underlying value of the stock. Let’s say you wanted to buy 100 shares of Microsoft stock to get a $25 dollar dividend every quarter. The inherent risk is that your underlying principal could lose a great deal of value in the time that you are receiving dividend payments. The value could fall so much that your $25 dollars every quarter does not offset the losses you are taking on in your principal. It’s always best to be mindful of this if you are looking to invest in a company because they have good dividend payments.
For all of you brainiacs out there who are thinking, well why don’t I just buy in before the ex-date, secure the dividend, and then sell out the following day? None of my principal will be at great risk and I will still receive the dividend.
This would be a great strategy but unfortunately, whenever a company pays a dividend, their stock is reduced by the amount of that dividend on the ex-date. For example, let’s say Microsoft is trading at $60.35 cents and they pay a $.25cent dividend. You buy 100 shares for a total cost of $6,035 right before the ex-date. On the ex-date, Microsoft will open the day down .25 cents ($60.10) because the dividend is subtracted. Your $6,035 investment is now only $6,010. You would be essentially breaking even unless Microsoft stock when up that trading day. For this reason, I don’t ever try to use dividend payments as some kind of short-term strategy.
- Dividend income from stocks can be a great additional steam of income to your portfolio.
- You have to be careful that you are not risking a great deal of your principal to try and receive these dividend payments
- If you are about to sell a dividend paying stock, see if it would be more advantageous to hold onto it if there is an ex-date coming up
- Often times, to get a substantial dividend you have to own thousands of shares of the underlying stock in your account so for many people this form of investing is not ideal till you have more capital built up.
- **Important Note** Just because a company pays a dividend now does not mean that they will pay one indefinitely. If the company begins to deteriorate financially then is some cases they will reduce/cut the dividend payment. This is rare but understand that it could happen.
Homework: Look up 3 different dividend paying stocks and find out what the ex-date is for their next dividend payment. Understand what day you would have to buy shares in order to receive that income.