How to Invest in Dividend Stocks

Dividend shares are shares of companies that pay out a portion of their earnings in the form of dividends to their shareholders. These shares tend to be held by more mature and established companies that generate stable and predictable cash flows. Investors who buy dividend stocks are looking for regular returns on their investments in addition to potential long-term capital gains.

One of the main advantages of dividend stocks is their stability. Companies that pay dividends tend to be less volatile than growth stocks, and their dividends can provide a cushion during market downturns. Dividend stocks also have a long history of providing consistent returns for investors. For example, the S&P 500 Dividend Aristocrats Index, which tracks companies that have increased their dividends for at least 25 consecutive years, has outperformed the broader market in the long run.

Why Does the Stock Price Rise or Fall?

The share price reflects how investors assess the current and future state of affairs in the company: how much its assets are worth, how effective its management is, whether the company has the potential to increase profits in the future.

The price of a share can rise when the company has been making profits for several years: investors expect high dividends and are very willing to buy its shares.

But even when a company decides not to pay dividends and invests all its funds in the further development of its business, this can still become a reason for its quotes to grow. This is because investors are hoping for an increase in the company's market share, which means potentially more profits in the future.

And vice versa: the price of a share decreases if the company operates inefficiently, does not earn anything and accumulates debts. In this situation, investors understand that it is pointless to expect a profit from such a company, and they begin to get rid of its shares.

However, it is always important to remember that the development of the economy is very difficult to predict and the previous growth of the company does not guarantee its growth in the future. And today's decline in share prices does not mean that they will become cheaper tomorrow.

What is a Dividend Gap and How to Get a Return on Time?

Very often, investors buy shares of a company for dividends as soon as their size becomes known. Together with the decision on the amount of dividends, the so-called closing date of the shareholder register, or the date of the dividend cut-off, is also announced: in order to receive dividends, the investor must be in the shareholder register on this date.

If the current dividend yield is higher than the market average, then after the announcement of the size of dividends, the company's shares can grow strongly and in the future cost more than before the announcement. Immediately after the date when securities are traded with dividends on the last day (two business days before the date of the dividend cutoff), the so-called dividend gap often occurs in the market. 

Investors who bought shares for dividends begin to sell them after the register closes, and the shares fall sharply in price – usually by a percentage close to the current dividend yield. However, over time, dividend gaps may close, that is, stock quotes are restored. This happens especially quickly during periods of lower interest rates and high investor activity.

What Is the Registry Closing Date?

The closing date of the register is the date on which the shareholders entitled to receive dividends are determined. This date is usually set a few weeks before the dividend payment date. All shareholders registered at the time of closing the register will receive dividends.

If you buy shares after the registry closes, you will not be eligible to receive dividends for that quarter. Therefore, if you plan to make money on dividends, make sure you buy shares before the registry close date.

What Is the Market Capitalization of a Company? How to Make Money on It?

Capitalization is the total value of all shares in a company. For example, if a company has 100 shares and the value of each share on the exchange is $2, then the market capitalization is $200. If one share attains $3, then the capitalization grows to $300.

To make money on the growth of capitalization, you need to wait for a good moment and sell shares. Until the shares are sold, in fact, you have no income. This situation is also called unrealized, or “paper”, profit, because it is only “on paper”, more precisely, on the screen of your smartphone.

For example, you bought shares for $50 each, and a month later their price rose to $100. It seems that you have doubled your investment, but this is not entirely true. Until you sell the shares at $100, you won't have that income – but there's always the possibility that the next day the shares will be back at $50 or even down to $25.

Typically, capitalization grows rapidly in young companies that are just starting to capture their market share. If you invest in them at the stage of small capitalization, you can get a return that is many times higher than the return on stocks and bonds of large companies with an established market share. But the risks are also very high: after all, no one knows for sure whether a young company will be able to become a new giant in its industry.
What is diluted earnings per share?
This is the percentage of a company's net income that is accounted for by one of its ordinary shares, taking into account possible changes in the total number of shares outstanding.Such changes may occur, for example, in the event of an additional issue or repurchase of shares.
The indicator of diluted earnings, or diluted EPS, is necessary to understand how the price of a share relates to the income that an investor can potentially receive from this share. And how this income can decrease if there are more shares of the company.

To do this, the calculation of diluted EPS takes into account the potential number of new ordinary shares that may appear due to the conversion of other instruments: preferred shares, bonds or options.

For example, at the end of the year, the company received a profit of $100,000 and is ready to distribute it in the form of dividends among 200 ordinary shares. Then per share will be: $100,000 / 200 shares = $500.

But, in addition, the company in the form of bonuses pays management options that can be exchanged for another 300 ordinary shares. And if management decides to exercise its options, the company will have a total of 500 shares.

In this case, the diluted earnings would be: $100,000 / 500 shares = $200 per share. That is, the dividend income for each individual investor will be less.

The presence of options or preferred shares that can be converted into ordinary shares must be reflected in the company's reports – they must be published every quarter. Most often, the indicator of diluted earnings per share is also indicated there.

What Are Growth Stocks and Value Stocks?

Growth stocks are securities of companies whose business model allows them to expand their market share much faster than the industry average. Accordingly, the share price of these companies is growing at a very high rate.

Value stocks are securities of large companies with an already established and well-predictable business. Since it is more difficult for large businesses to continue to grow in size, the share price of these companies increases at a much more modest rate.

Two investment strategies are popular among stock market participants.

Buying growth stocks – here investors are betting that the price of such shares will continue to rise at a faster pace, and at the right moment they will be able to sell them profitably.

The disadvantages of this approach are that, as a rule, such companies do not pay dividends, directing all free cash flow to the development and expansion of business in their own or related industry. That is, in fact, an investor can receive income only by selling shares.

For example, Amazon is a classic growth company. It is engaged in e-commerce and shows growth in revenue and capitalization even in times of crisis due to the constant expansion of its influence in the market. Since 2016, the value of the company's shares has grown by 379%, while the US securities market has grown by 105%.

Buying value stocks – here, investors are betting on a company's established business model that allows it to generate high returns and distribute it to shareholders. That is, investors receive a constant cash flow in the form of dividend payments.The disadvantages of this approach are that the growth in share prices of such companies rarely exceeds industry-wide rates.

For example, companies of value include telecommunications giants like AT&T in the US. These companies are paying good dividends, but their share price is growing at the level of the entire market, because they have already occupied their niche and a significant increase in the client base – and therefore revenue –  is not expected in the near future.

What Are the First, Second and Third Tier Stocks?

An echelon is a conditional concept that shows the popularity of specific stocks among investors. Most often, three such echelons are distinguished.

The first echelon is the companies with the biggest names, stable business and high market capitalization. Their shares are always in high demand, so they can be easily bought or sold on the stock exchange, and price spikes for first-tier stocks are rare. These stocks are often referred to as blue chips.

The second tier is no longer such large and well-known companies, so their shares are much less popular among investors. Even in the main trading session on the exchange, it may not be possible to quickly sell such shares at a bargain price, because there are not so many people who want to buy them. Because of this, prices for second-tier stocks can change by 10% or more in one trading session.

The third tier is little-known mid- and small-cap companies, which are considered the most risky investments. There are always very few people who want to buy them: it happens that not a single deal is concluded for shares of the third echelon for several days. Therefore, the price for them can change very sharply - by 20% or more in just one session.

In order to distinguish third-tier stocks from blue chips, in addition to the name, it is worth looking at trading volumes.

What Are Blue Chips?

This is the name of the shares of the most famous companies on the market with a long history, an established reputation and stable financial performance.
Blue chips have characteristics that make them stand out from other securities in the stock market.

High liquidity – blue chips account for the bulk of trading in the securities market, so these assets are easy to buy or sell in large volumes at any time of the exchange. When can I trade on the stock exchange

Good business performance – such companies have stable income growth, reliability and high capitalization for at least several years. This may indicate that interest in the company is caused not only by the speculative mood in the market, but also by a really working business.

Leadership in their industry – typically blue-chip stocks are leaders in their economic industry or are in the top five.

Who Are Dividend Aristocrats?

These are companies that consistently pay dividends every year and have been doing so for many years. For example, many American companies, which are most often included in the list of dividend aristocrats, have been paying stable dividends to their shareholders and even increasing their size year by year for more than 25 years.

These are companies that have been increasing their dividend payouts year on year for over 25 years. There are three more criteria that a company must meet in order to receive the title of aristocrat:

• Presence in the S&P 500 index.
• Capitalization starting from $3 billion dollars.

The average daily trading volume for the paper is from $5 billion.

In addition to dividend aristocrats, there are also dividend kings in the stock market. These are companies that have been raising dividends for the past 50 years. At the same time, there are no requirements for capitalization, liquidity, and presence in the S&P 500 for dividend kings.

If you choose between kings and aristocrats, the latter look more reliable due to the additional requirements for capitalization and liquidity. After all, the larger the company, the more stable it is. Such companies have a high credit rating, they are included in indices and portfolios of large funds. This is additional evidence of the reliability of the asset.

Benefits of Dividend Aristocrats

Stable dividends and the possibility of their reinvestment – this triggers the effect of compound interest. Historical data shows that every dollar invested in the S&P 500 in 1930 would have generated $115 by 2019 without dividend reinvestment. And with reinvestment, each dollar would turn into $3,626.

Reliability. In order to pay and increase dividends for many years, the company must have high-quality management, high stability and safety margin. The same thesis is confirmed by credit ratings: in the list of dividend aristocrats, the share of companies with a rating of at least A − is much larger than in the S&P 500.

Dividends above the market. Aristocrats combine profits both through the growth of the asset itself and through increased dividends. From 1999 to 2019, Aristocrats posted an average dividend yield of 2.5%, compared to 1.8% for the broad index.

Reduced volatility. This distinguishes dividend stocks from growth stocks. If a company can maintain a stable level of dividend payments, then during collapses this factor should keep quotes from falling sharply: when quotes decline, dividend yield becomes too “tasty”, shares are immediately bought out.

But the explosive growth of quotations can not be expected. In such stocks, there will be no increased sentiment, as with Tesla, speculation and short runs to disperse the price. Even in the index of dividend aristocrats, there is an increased concentration of non-cyclical securities: its largest share is the defensive sector Consumer Staples, consumer essentials.
Disadvantages of Dividend Aristocrats

Weak portfolio structure. If we decompose Dividend Aristocrats into sectors, then these sectors will receive the maximum weight:

Consumer Staples, essential goods - 22.2%.

Industrials, industrial – 21.1%.

Materials, raw materials – 12.6%.

How to Diversify Your Portfolio by Sector?

Here are the sectors with the smallest share:

IT, information technology, in particular Microsoft, the largest company in the world by capitalization.

Communication Services, communications. This sector contains the media industry, with giants such as Google and Facebook.

The proportions of the sectors are not optimal and do not correspond to the spirit of the times. Such a portfolio lacks manufacturability. But it was the technology sectors that became the locomotive of the index in the last business cycle.

Manufacturability. If we plan our portfolio for a strategic perspective of 10-20 years, then we need to bet on companies that will not lose their relevance in the new technological order.
Since the first industrial revolution in the 18th century, humanity has gone through five successive technological cycles. We are now at the beginning of the sixth, driven by bio- and nanotechnologies, genetic engineering, artificial intelligence, renewable energy.

In addition, the products of technology companies usually have a large added value, which provides the business with high margins. Already, two technology sectors – information technology and healthcare – together occupy 40% of the capitalization of the S&P 500 index.The trend towards a new technological paradigm can be seen by examining the changes in sectoral shares in the S&P 500 index over the last business cycle.

Life cycle of enterprises. Companies are born, rise to their feet, reach their peak, and then grow old and die. Some become real long-livers – those who are able to accept the challenge of time, rebuild and move on with renewed vigor.

When an investor builds a portfolio of dividend aristocrats, by and large he is betting on the old guard. Yes, they are reliable and experienced players in the market, but for most of them the heyday is over. Business begins to generously share profits with shareholders when all the ways of further growth have been exhausted.

And vice versa, if a well-managed company has growth points, then it will join the race - direct profits to expansion, R&D, capital expenditures. In this case, the payment of dividends is an inefficient distribution of profits. And one of the main reasons is withholding taxes on dividends. For the US, this means that 30% of the profits sent to shareholders will go to the state.

Therefore, the investor, provided that he directs his free capital to shares, it is preferable that the profit remains within the growing company. If a company wisely uses financial leverage, its performance will grow – and this will be reflected in quotes. In this sense, the return on asset growth is much higher than the investor's return on dividends.

It is also worth noting that there are different categories of investors. Someone relies on passive income from their portfolio, and they need stable and ongoing dividend payments.This may apply to people of retirement and pre-retirement age. In this case, a conservative approach and a bet on dividend companies are fully justified.

And for a young investor who plans his portfolio for 20-30 years ahead and does not depend on receiving dividends at the moment, it is more profitable to bet on growing companies. In a sense, these companies will age with the investor. Over time, the explosive growth potential will be exhausted, and they will move to a more generous dividend policy.

To sum up: dividend aristocrats are a great option if passive income is needed here and now. If you are ready to look at the future, then you need to include growing assets in your portfolio.

What Is a Dividend Calculation Base?

Dividends are usually awarded based on a company's earnings over a certain period of time. However, in order to understand how dividends are calculated, it is important to know what base is used for the calculations.

There are two variants of dividend calculation base: income base and profit base. An income base is used when a company is not earning a profit but has a stable cash flow that can be used to pay dividends. In this case, dividends can be paid even if the company has not earned a profit.

The profit base is used if the company earns a profit. In this case, dividends can be paid out of the company's profits, after deducting all expenses and taxes. Typically, companies set a certain percentage of their profits to be paid out as dividends.

Forecasts of Earnings on Dividends

Forecasting earnings on dividends is an important step for those who plan to invest in company stocks. There are several factors to consider when predicting dividend earnings:

1. History of dividend payments. See how much the company has paid dividends in past years. If dividends have been rising, then this may be a good sign.
2. Financial indicators of the company. Research how much profit the company is making and what expenses it has. A company with high margins and minimal costs is more likely to be able to pay higher dividends.
3. The state of the market. Consider the general state of the market in order to understand how the company can perform against the background of its fluctuations.
4. Prospects for growth. If the company is actively developing and has prospects for growth, then this may be a good sign for investors.

What is the Dividend Stability Index?

When choosing dividend stocks, you need to consider the Dividend Stability Index (DSI)
It is calculated by the formula: DSI=(Y+G)/14, where Y is the number of years for which dividends were paid, G is the number of years in which the dividend for the year was greater than the dividend for the previous year.

We interpret the result obtained as follows:

DSI>0.6 – shares are promising in terms of receiving dividend yield

0.4<DSI<0.6 – the attractiveness of the stock in terms of receiving dividends is average

DSI<0.4 - dividends are paid rarely and unstable, shares are unattractive for inclusion in the dividend portfolio.

Average Annual and Current Dividend Yield

When choosing stocks for a dividend portfolio, it is useful to study the historical dividend yield of the company's shares and compare it both in dynamics and with industry competitors:

Average Annual Dividend Yield = All Dividend Payouts on Shares for the Year/Average 
Annual Market Value of Shares

When buying shares for dividends, investors are usually guided by the current dividend yield:
Current Dividend Yield = Declared Dividend / Current Market Value of Shares

Reinvestment is the process by which income received from investments is invested back into a portfolio of assets instead of being spent. This process can have significant benefits for investors, and we will look at several reasons why reinvestment can be beneficial.

Why Reinvest?

The idea behind reinvestment is to reinvest interest in the same financial instrument or other asset as the original investment. In the first case, interest is charged on the new increased amount; in the second case, the investor has the opportunity to choose, for example, a more risky and more profitable investment. A mixed choice involves reinvesting part of the interest in the same investment product, and part in a new investment product. Reinvestment can also be associated with a long-term goal or a short-term speculative profit tactic. It all depends on the goals of the investor, his experience and attitude to risk.

What is Diversification?

Diversification is an investment strategy that consists of spreading your investments among different types of assets and instruments in order to reduce risks and maximize potential profits. When you diversify your portfolio, you spread your investments across different asset classes such as stocks, bonds, cash, and others, as well as across industries and companies.

The goal of diversification is to reduce the risks associated with concentrating your investments in certain areas. If all your investments are in the same asset or company, then you are at risk of a significant loss if something goes wrong. When you diversify your portfolio, you allocate your investments in such a way as to reduce the impact of any adverse events.

What Is the Advantage of a Dividend Strategy?

The dividend strategy is one of the most stable and reliable investment approaches in the stock market. It is based on passive income, which is obtained from dividends paid by companies. Unlike a strategy based on the growth of stocks, a dividend strategy provides a constant income and allows investors not only to save capital, but also to receive a stable income.

In addition, a dividend strategy allows investors to participate in the success of the companies they own. When a company is profitable, it can pay higher dividends, which increases investor returns. Also, the dividend strategy allows you to reduce the risks of investing, since income from dividends may be more stable than income from rising stock prices.

How to Build a Dividend Portfolio?

There are several ways to build a dividend portfolio. First, you can choose an index fund that invests in stocks of companies with high dividend yields. Secondly, you can choose individual stocks of companies with high dividend yields and build your portfolio. At the same time, it is important to take into account not only dividends, but also other factors, such as the financial condition of the company, its market position, plans for the future, etc.

Here are three main steps:

Learn which companies pay dividends, how much and how often. It is convenient to do this with the help of aggregators or special ratings published by business media and research companies.

Choose companies that have the highest dividend yield. Here it is also worth considering the price of shares and its dynamics: even if the profitability is not the highest, but the shares are constantly growing, you can earn extra money by selling them.

After selecting several companies and comparing them by key indicators, familiarize yourself with their dividend policy and reporting for previous years. This will help to more accurately predict profitability in the short and long term.

What Reduces Dividends?

The company determines the amount of dividends individually, but it is influenced by objective factors:

• poor financial performance of the company;
• increase in expenses (for example, expansion or launch of a new direction);
• reduced investment and unavailability of cheap loans;
• unstable situation on the market, when it is better to send profits to reserve funds.But some companies continue to pay dividends even with poor financial performance – at the expense of pre-established funds. This information can also be found in the public reporting and dividend policy of the company.

Nuances to Consider

There are a few things to keep in mind when investing in dividend stocks. 

First, you can't rely on high dividend yields alone. It is necessary to carefully study the financial statements of companies and analyze their financial condition. 

Secondly, you need to monitor changes in the company's dividend policy. If the company decides to cut its dividend payments, this could have a negative impact on investor returns.