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What in the world
is a dividend?
By Ken
Kurson • Bankrate.com
Buying stock in a company gives you a sliver of ownership.
As owners, shareholders are entitled to participate in all the goings-on
of the corporations: They vote on the appointments to the company's
board of directors and can attend yearly shareholder meetings, where
they can grill the big wigs about the company's performance.
And of course, shareholders are entitled to participate
in a company's profits. Many companies periodically pay a percentage
of their profits to their shareholders. These payments are called
DIVIDENDS and are usually paid on a quarterly basis. If you own
a hundred shares of a stock that pays a $2 dividend, you can expect
a check for $50 each quarter -- $200 a year. If that stock happens
to be trading at $40, then its YIELD is 5 percent, since $2 is 5
percent of $40.
Investors can either pocket those checks or use the
money to buy additional shares of the stock, which is called DIVIDEND
REINVESTMENT What
in the world is a dividend reinvestment plan. Some companies
tend to pay very small or no dividends -- such as those that are
recently public or those in quickly growing industries (like high
tech companies) or, of course, companies without any profits. Other
companies reliably pay large dividends -- including many utilities
and large, older companies like carmakers and tobacco companies.
In a growth fueled stock market like we've had the
past decade, those quarterly checks have seemed quaint and old school
-- money was to be made in the capital appreciation of stocks like
Microsoft (Nasdaq: MSFT),
which doesn't pay a dividend. But the perspective changes in a year
like this one, with all the major averages down significantly for
the year. Consider a company like Philip Morris (NYSE: MO).
Trading at this writing at 31, its $2.12 yearly dividend means a
yield of 6.8%. In other words, Philip Morris investors who buy at
31 get at least 6.8 percent on their money -- better than most CDs
and money market accounts -- and also have a chance at capital appreciation
if MO goes higher than 31. Compare that to the Nasdaq's 18 percent
loss for the year so far, and suddenly high dividends don't look
so bad.
Any good newspaper stock table lists a company's dividend
payment and current yield. For tax purposes, dividends are taxed
as ordinary income in the year they're received. A stock that paid
a 5 percent dividend and appreciated in value 5 percent in one year
is said to have a 10 percent "total return" for that year.
It'd be great to find a stock that pays a fat dividend
and also raises in price a lot, but there's a reason stocks like
that are just about impossible to find. In general, the higher a
stock's dividend, the less of its profits are being poured into
growing the company. That's why high dividend payers tend to be
stocks that don't have a lot of growing left to do, like electric
utilities and established industry leaders. These are known as INCOME
STOCKS since they produce income for the shareholder. Investors
generally don't expect the share price to skyrocket, but they also
don't expect it to plummet, which is why safe stocks with a long
history of high dividends are called "widow and orphan" stocks.
On the other hand are young and quickly growing companies.
These companies need to spend every dollar of profit expanding operations
-- hire more people, build more plants, whatever. Paying dividends
would be shortsighted.
One stock-picking theory, called the Dogs of the Dow
(aka the Dow dividend theory), uses dividend yield as its basis.
On the first trading day of the year, you invest an equal amount
in the 10 members of the Dow Jones Industrial Average that have
the highest yield. After holding for a year, you sell those 10
and buy equal portions of the new 10 highest yielding (some of which
will undoubtedly be the same stocks). Remember, yield moves in the
opposite direction of share price -- a stock whose price doubles
while it still pays the same dividend yields half as much. That's
why the highest-yielding stocks are called dogs -- because their
share prices have either gone down or stayed level. Check out
What in the world are the dogs of the Dow for more info.
As this strategy has gained followers, several brokerages
have begun to sell all 10 of the stocks in a basket called a unit
trust, which means you only have to pay one commission, rather than
ten. Alternatively, you might consider the Puppies of the Dow, in
which you figure the 10 highest yielding Dow stocks but only buy
the five with the lowest share price.
-- Posted: Oct. 18, 2000
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