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What are Dividend stocks?

Stocks are classified as dividends stocks if the shareholders are rewarded on a regular and consistent basis with the significant portion of the income of the companies in which they had invested. When you invest in the stock of a company, you will be expecting returns on your investment. Returns on investment in stocks usually come in three ways. It can come through appreciation in the stock price, dividend income and the hybrid of the two. But when the returns you get from your investment in a particular stock is largely through dividend income; that stock can be regarded to as a dividend stock. Dividend stocks are generally known for the payment of dividends to shareholders in a consistent manner. For you to really understand this topic, let me explain the features that distinguish dividend stocks from the other types of stocks beloe.

Characteristics of dividend stocks

If you are looking for high dividend stocks to buy, these will be the features you may watch out for. In other words, I will call it the characteristics of high dividend stocks.

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• Regular dividend income: Dividend stocks are known for their consistency in the payment of dividend income to shareholders. That is why it is usually the toast of income seeking retirees. It is a good source of passive income. Also, investing in dividend stocks helps shareholder realising income from their investment without reducing their stakes. If you invest in growth stocks, the only way you may be able to realise income from your investment is by selling part of the stocks you own. And this will definitely reduce the number of shares you hold in the company. Unlike growth stocks which may not pay any dividend at the end of the year, investors in dividend stocks usually look towards earning income from their investment. Investors have the option of utilizing their dividends to meet their immediate needs or reinvesting it to grow their wealth.
• Low risk: Dividend stocks are considered low risk stocks because of the level of assurance the investors have that the companies will deliver returns on their investment. This assurance comes as a result of the history of consistent payment of dividends by the companies. Also, the companies in this category are considered stable. They must have gone through bad economy and still survived. Therefore, investors are less afraid of the possible collapse of such companies.
• Less volatility: The level of confidence the investors have in dividend stocks makes the stock price to be less volatile. That is not to say that the share price will not fluctuate, the level of the fluctuation is not as high as that of growth stocks.
• High market yield during market crash: Dividend stocks can still rewards investors when there is crash in stock price in form of high dividend yield. During recession when prices of all types of stocks are generally low, there may not be a significant appreciation in stock prices. But dividend stocks have a way of compensating their shareholders through payment of dividend income. I will give more explanation on dividend yield later.

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Factors to Consider before buying high dividend stocks

If you want to invest in high dividend stocks, there are certain things you may not overlook. I want to believe that the reason you want to buy high dividend stocks is for you to earn passive income from your investment. If this assumption is true, below are some areas you may like to consider.

• Revenue: Revenue is the total sales generated by a company. Top dividend stocks are known for their market dominance. They usually enjoy good market shares thereby making them to continuously post good revenue year in year out. However, you may need to look beyond the market share. You need to consider the industry as a whole. What impact are the environmental factors having on the industry and the company? That a company has a good history of high revenue may not make it to qualify to be listed among the best dividend stocks this year. For instance, technology has changed the way we do business today. If any company fails or cannot adapt to the technological change, its revenue may soon begin to nosedive. Companies producing diskettes might be posting huge revenue in the past years. But today, no one is using diskettes any more. People now use disk and memory cards. If a company cannot earn revenue, it will be difficult to make profit let alone sharing of income to shareholders in the form of dividends no matter the dividend policy the company has in place. Therefore, you need to look at the trend of the revenue of the company. Is it growing or declining? What about its market share? You can get to know about this when you compare the revenue of the company with the other companies in the same industry. What can you say about the future of the company? Are there external factors that can adversely affect the company’s performance? Your answers to these question will provide a guide as to whether you can invest in the company
• Earnings: Earning is another critical issue to consider if you are looking for high dividend stocks to buy. Earnings here mean profits. Revenue will not count if it doesn’t translate into profits. There are many things that will determine whether a company will post profits or not. If a company cannot generate enough revenue that is above its breakeven point. It means such company will not have any profit to report. Breakeven point is the point where the revenue of a company is equal to its marginal cost. At this point, the company will neither make gain nor loss. If the company cannot source its products at competitive prices, this will affect its margin. Also, if its overheads is too high, the company may likely record a loss or shrunk profits at the end of the year, meaning no or less dividends to the investors. Examples of overheads that can easily erode profits are huge staff overhead costs and interest payment. While it is good to motivate employees in order for them to perform maximally, excessive salary can limit the amount of profits that will be available for investors to share. Also, if the company is using debts to finance its operations, it may be paying through its nose to service the debts in form of interest payments.
• Earnings per Share (EPS): Another point that is close to the one mentioned above is the earning per share. It is not good to focus on the total earnings of a company especially if you are comparing the performance of two companies. What is more important to you is the proportion of the earnings attributable to its shareholders. In order to arrive at the company’s Earnings per share, you need to divide its total earnings after interest and taxes by the total number of the shares of the company. Let’s compare the performance of the two companies below:

	Company A	Company B
Earnings ($)	650,000,000	400,000,000
No of shares	20,500,000	10,000,000
Earnings Per Share (EPS)	$31.71	$40.00

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From the above, if you are focusing on company’s earnings, you can easily jump into the conclusion that Company A is better. But that is not the way to analyse performance when it comes to stock investing. If you analyse it further by calculating the Earnings per Share of the two companies, you will realise that Company B actually performed better. The Earnings per Share of Company B is $40 while that of Company A is $31.71 despite the fact that Company A achieved higher earnings.

• Dividend payout ratio: We are getting closer to the objective of this topic. The reason you want to buy high dividend stocks is to be able to generate passive income from your investment. But if you invest in a company that is not willing to pay out dividend, you will not be able to achieve this objective. That a company records attractive earnings or Earnings per Share does not guarantee that you will be paid dividend. Each company has its own dividend policy. Some companies don’t pay dividends. They invest their profits back into the company instead of raising fresh capital or loans to finance their expansion. So, if you are seeking for high dividend stocks, you need to look at the history of the company on how it has been paying dividends on a consistent basis. The proportion of the dividend that is paid to the shareholders in relation to the company’s earning is known as dividend payout ratio. This is usually expressed as a percentage. If you are looking for the highest dividend stocks, this ratio may help you in your assessment. While there is no standard dividend payout ratio in particular, it is expected that the ratio should not be too high. However, the dividend payout ratio that will be okay for you with depend on your income expectation. It is suggested that the dividend payout ratio should be within the range between 60 and 70%. Some companies may have their dividend payout ratio as high as 90%. It all depends on their policy and cash requirements. The implication of high dividend payout ratio is that, the company is paying out most of its earnings to the shareholders. Such company may have little left to finance its expansion. Therefore, if you want dividend income and at the same time like to invest in a company that has growth potential, you need to consider companies that keep their dividend payout ratio considerably low. Your best dividend stocks may be the ones with dividend payout ratio below 60%.
• Dividend per share: Just like the Earnings per Share discussed above, you need to concentrate more on the dividend income that will actually come to you as a shareholder of a company. Dividend per Share (DPS) is arrived at by dividing the total dividend declared by the number of the issued shares. Let’s illustrate this with figures:

	Company A	Company B	Company C
Earnings ($)	650,000,000	400,000,000	400,000,000
Payout Ratio	80%	60%	80%
Dividends	520,000,000	240,000,000	320,000,000
No of shares	20,500,000	10,000,000	10,000,000
Dividend Per Share (DPS)	$25.37	$24.00	$32.00

I think you can see how different factors contribute to the dividend you can earn from a company. It begins with the earnings, followed by the dividend policy of the company which will determine its dividend payout ratio. It is this dividend payout ratio that will determine the total dividends that a company will declare as income to be distributed to its shareholders. Ultimately, the dividend per share is the amount each shareholder will receive on every unit of shares he holds in the company. So, if you are holding 1,000 shares in each of the company, your dividends will be $25,366, $24,000 and $32,000 from the three companies respectively. Please note that I did not put any tax into consideration here. On the other hand, if you are looking for the highest dividend stocks to buy, then company C will be your top dividend stock.

From the illustration above, you can see clearly how dividend payout ratio can impact your dividend income. Company B and Company C have the same financial information except that the dividend payout ratio for Company B is 60% while the dividend payout ratio for Company C is 80%. It is the 80% dividend payout ratio of Company C that made it to be the best dividend stock among the three companies. Also, despite the fact that Company A recorded the highest earnings and also 80% dividend payout ratio, its Dividend per Shares is lower as a result of its large number of outstanding shares. I hope it is not confusing. If you are not getting it, I suggest you go through it again. It is very easy to understand

• Dividend yield: Another thing I like to discuss under dividend is the dividend yield. Before I explain this, I will like to use a term that you are used to. The term is “rate of return”. For instance, if you put your money in a saving account that pays 3% interest. Your rate of return will be 3%. So, in the same vein, if you are investing in high dividend stocks, you will like to know your rate of returns. In this case, if all you get from the investment in the stocks is your dividend income, then your rate of return will be the dividend yield. So, what is dividend yield? Dividend yield is the dividend per share divided by the share price of a stock. Let’s continue with our example discussed above:

	Company A	Company B	Company C
Dividend Per Share (DPS)	$25.37	$24.00	$32.00
Share Price	$100	$150	$160
Dividend Yield	25.37%	16.00%	20.00%

In my first example, we ranked Company C as the best dividend stocks among the three companies. This is because the company has the highest dividend per share. But in reality, the share price of the three companies cannot be the same. As an investor, you will definitely be looking for the best dividend stocks that will yield the highest returns on your investment and this may not necessarily be the dividend stocks with the highest dividend per share. From this last table above, even though company C seemed likethe highest dividend stock, company A has the highest dividend yield. However, one may not overlook the growth potential of company B as a result of the part of its earnings that is re-invested into the company. Therefore, when you are analysing stocks, you need to consider many factors and then focus more on the areas that suits your investment goals.

• Calendar: As an investor, you need to be familiar with company’s calendar. Each company has its own financial year which usually covers twelve month period. Majority of companies run their financial year from January to December of every year. But this is not the case for all the companies. So, if you want to buy dividend stocks, you should know when they are ending their financial year and the date they will close their book for the purpose of dividend payment. If you buy stocks before the register is closed even though dividends have been declared, you will still enjoy the same dividends with other investors who have invested in the company long in the time past. The date before register is closed for dividend is called cum-div date while the date after the register has been closed is call Ex-div date. If you buy stocks a day after the company has closed its register, you will not be entitled to the dividend declared for that period. Another important date you need to know is the dividend payment date. Companies don’t usually pay dividend the same date the dividend is declared. They will pay later. Knowing the date dividend will be paid can help you in planning your cash flow.
• Cash flow: Cash is the life blood of any business. It is one thing for a company to make paper profits; it is another thing for it to have cash to back it up. If a company is struggling to pay its suppliers because of insufficient cash, such company may not be able to pay dividends to its shareholders. It is possible that a company sells on credit in order to achieve its revenue target in order to impress shareholders. Without proper and adequate debt recovery efforts, some of the debts may turn bad. No high dividend stocks will be able to sustain its dividend policy consistently if faced with liquidity problems.
• Change in Management: If there is change in the management of a company, the new management may alter the dividend policy of the company. The reason is that, they will probably need money to finance their new expansion plan. And this may disrupt the usual dividend payout ratio.

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I believe you now have a basic understanding of how to analyse high dividend stocks. Nasdaq may be a good place to search for high this type of stocks. If you have any other thing you may want to know which I did not cover, you can add them as comments below. I will be looking forward to read your comments below.

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