One of the more interesting questions I was asked recently had to do with dividend stocks. My brother was trying to figure out what to do with money withdrawn from a mutual fund. He asked about dividend stocks because he had heard that they offer a reasonably stable return — plus cash pay outs. I thought some basic information on dividend stocks might be of interest to him, and to MoneyNing readers.
An overview of dividend paying stocks
Basically, dividends represent a portion of the profits that some companies see. They are paid regularly to stock holders. Many companies that pay dividends make their pay-outs quarterly, but others pay monthly and some pay semi-annually or annually. Companies express the amount that they pay in dividends as a percentage of the stock price.
Dividends are payments made to stock holders on top of anything they would get from selling the actual shares of the stock. Companies that pay dividends do so with a portion of their profits. Companies can stop paying dividends when they want, or adjust the dividend yield as they see fit.
Why dividend stocks can be good investments
As with all investments, dividend stocks aren’t for everyone. However, for some, they can make great additions to an investing portfolio. Dividend paying stocks that regularly pay out a portion of profits are generally stable companies. (Dividend aristocrats, for example, are companies that have increased their pay outs every year for the last 25 years — even during recessions.)
If a company consistently pays dividends, keeping the yield fairly stable, it is often an indication that the company has solid profits year after year. Not only will you receive an income stream from such a company, but the stock price is likely to rise over the course of time too.
It is true that the stock price of dividend players might not rise dramatically for these types of stocks. However, stable returns can usually be expected over time, and many of the best dividend paying companies see their stock price recover at the end of a stock down cycle. Dividends are great because they provide a revenue stream that you can use immediately without selling stock, and their presence can indicate a solid stock investment choice.
Another reason that dividend paying stocks can be good investments for some is the presence of reinvestment plans. Dividend reinvestment plans (DRIPs) allow you to automatically invest your dividend pay outs back into the stock. So, if you buy stock in Coca-Cola and enroll in the company’s DRIP, your portion will automatically buy more shares of Coca-Cola stock every time there is a dividend pay out.
Often, you are not charged a transaction fee for using DRIPs too, which is an added bonus. In some sense, it’s the equivalent of receiving shares of Coke at no cost to you, helping you build up your shares. Later, when you sell at what will presumably be a higher price, you reap the benefits of having more shares.
Who might benefit from dividend paying stocks: Someone who is interested in building an alternative income stream, especially those interested in income diversity, can benefit from developing a portfolio that includes dividend paying stocks. These stocks can also be good choices for someone who wants good value, and wants to see reasonable growth without a great deal of risk.