How to Make Money with Dividends: A Complete Guide to Dividend Investing, Payout Strategies, and Long-Term Stock Market Growth
Investing in Dividends: A Complete Guide
How to Make Money in the Stock Market Through Dividend Payments
Earning dividends is one of the ways to generate income in the stock market, as we explored in the previous module. Today, we will take a deep dive into dividends, analyze whether investing in them is worth it, and explore the long-term benefits of dividend stocks.
What Are Dividends?
Dividends represent a portion of a company's profits that is distributed among its shareholders. To better understand this concept, let's imagine a restaurant run by two partners with equal ownership. The restaurant generates revenue from serving meals, and after covering operating expenses like staff salaries, rent, and utilities, the remaining profit can be distributed as dividends.
For a real-world example, let’s examine Coca-Cola. In 2019, 2020, and 2021, the company reported varying profits, with a dip in 2020 due to the pandemic. Coca-Cola allocated $7.225 billion in dividends in 2020 and projected a similar payout in 2021. This payout ratio, known as the "dividend payout ratio," measures the percentage of profits distributed as dividends.
Coca-Cola, unlike the restaurant example, has millions of shareholders. The company divides total dividends by the number of shares to determine the dividend per share. For instance, a shareholder with 100 Coca-Cola shares in 2020 would have received $164 in dividend payments.
How Often Are Dividends Paid?
Dividend payments vary by company. Some corporations, like Coca-Cola, issue dividends quarterly, in April, July, October, and December. Others, like Red Eléctrica, distribute dividends semiannually, with unequal payments throughout the year. Reality Income, on the other hand, follows a monthly dividend payment structure.
The Dividend Payment Process
The process for distributing dividends follows a structured timeline:
Dividend Declaration Date – The board of directors announces the dividend.
Ex-Dividend Date – Investors must own shares before this date to qualify for the dividend.
Record Date – The company verifies shareholders eligible for the dividend.
Payment Date – The dividend is distributed to shareholders.
For example, in 2021, Coca-Cola declared a dividend on February 18, with an ex-dividend date of March 12, a record date of March 15, and a payment date of April 1. Shareholders who owned stock by the market close on March 11 received the dividend.
Stock Price Adjustments After Dividend Payments
On the ex-dividend date, a stock’s price typically drops by the dividend amount, reflecting the company’s reduced cash reserves. For example, Red Eléctrica's stock price decreased from €17.35 to €16.70 in June 2020 after issuing a dividend of approximately €0.75 per share. This adjustment is natural, as the company’s market value temporarily declines by the dividend amount.
However, over time, companies replenish their cash reserves through continued business operations and profitability, enabling them to sustain future dividend payments.
The Impact of Dividends on Stock Market Performance
When analyzing stock market performance, many investors focus solely on stock price appreciation. However, dividend payments significantly impact total returns. Most stock indices, like the IBEX 35, do not account for reinvested dividends in their charts, creating a misleading perception that stocks are less profitable than they actually are. The DAX, Germany’s stock index, is an exception, as it includes reinvested dividends.
Should Companies Pay Dividends?
A company should only pay dividends if it cannot reinvest profits more efficiently. If a company can achieve high growth by reinvesting earnings, it should prioritize expansion. Similarly, companies with significant debt should allocate profits to debt reduction. However, businesses with stable growth and manageable debt levels can allocate a higher percentage of profits to dividends, as seen with Coca-Cola.
Is Investing in Dividend Stocks Profitable?
Investors receive dividends in two forms:
Cash Dividends – These are subject to taxes, which we will cover in another module.
Stock Dividends (Scrip Dividends) – In this case, companies issue new shares instead of cash payments.
Stock dividends can be misleading. While shareholders receive more shares, the company’s total value remains unchanged. Therefore, each share becomes less valuable, making stock dividends a less attractive investment strategy.
The Key to Successful Dividend Investing
Investors make money in the stock market through dividend payments and capital appreciation. However, a high dividend yield alone does not guarantee profitability. If a company’s stock price declines over time, dividend income may not compensate for capital losses.
For instance, while companies like Telefónica and Kinder Morgan have historically offered high dividend yields, their stock prices have been declining for years. An investor who bought Kinder Morgan shares in 2015 would earn only a 2% yield based on their initial investment, even if the current dividend yield is 5%.
Comparing Dividend Yields vs. Stock Price Growth
Consider two stocks:
Stock A pays a 5% dividend and appreciates by 10% annually.
Stock B pays a 7% dividend but grows only 2% per year.
Despite a higher dividend, Stock A generates higher total returns due to superior capital appreciation.
Conclusion: Is Dividend Investing Right for You?
Dividend investing plays a crucial role in long-term investment strategies, but it is essential to evaluate total returns, not just dividends. Selecting companies with strong fundamentals, sustainable dividend policies, and consistent stock price appreciation is key to successful dividend investing.
For personalized premium advice, reach out to us at silverfontinvestments@gmail.com For general inquiries, you can also contact us at silverfontinvestments@gmail.com
Disclaimer: The content of this article is for informational purposes only and does not constitute financial advice, investment recommendations, or a suggestion to buy or sell assets. Cryptocurrencies and digital assets are highly volatile and may involve significant risks. Always conduct your own research (DYOR) and consult with a professional financial advisor before making investment decisions. The author and the website are not responsible for any loss or damage that may arise from investments based on the information provided.
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