What is a Dividend?
I’ve shown in countless posts my dividend income on a monthly basis. For the benefit of new investors and the layman: “A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.” That’s the official definition.
Fun fact: Companies have been paying dividends to shareholders for over 400 years. The first company to ever pay a dividend was the Dutch East India Company in the early 1600s.
Cash dividends are usually distributed to shareholders quarterly. However, some companies pay dividends annually or semi-annually (twice per year). There are no hard and fast rule, each and every company determines its own payout schedule. Some companies will even pay a special (one-time) dividend every so often. These special payouts are separate from the company’s regular payout schedule and are not factored into the stock’s dividend yield.
As always, there are however always exceptions, some of you may notice up and coming growth companies do not distribute any dividends for the first few years. This is because management and major shareholders have decided to retain the profits earned by the business for one purpose – growth. On the other hand, some companies distribute 100% of their earnings as dividends to shareholders. These are mostly mature companies whose growth has peaked. Do note that a peak in growth does not mean that the company’s share price will not increase in value.
Why Do Companies Pay Dividends?
So your next question – Why does a company distribute dividends?
Companies sell shares to the public to raise money, which they then use to fund existing operations and expand their businesses. One way to look at a dividend is as a reward given to shareholders for owning stock in the corporation.
Lets use my friend Mr.S from a previous post as an example. Mr.S has saved up RM10,000 and plans to invest in stocks, he purchases 1,000 units of shares in Company A at RM10 per share. Now, Mr.S who previously had RM10,000 in savings is now an investor – he is a part owner and shareholder in Company A. As owner of a business, one would generally expect profits generated from the business to flow back into his/her pockets. This is why a company distributes dividends. So for your long investing journey ahead, although it’s easy to forget sometimes, a share is not a lottery ticket… it’s part-ownership of a business.
How Do I Collect My Dividend Income?
If you buy a dividend-paying stock and meet the eligibility requirements (determined by its dividend dates), you will receive dividends. These dividend payouts are issued on a per-share basis. Using the previous example, if Company A pays out 20 cents per share, Mr.S would receive a total of RM200 (RM0.20 x 1000 shares) in dividends per year, which translates to a 2% dividend yield.
Investors used to receive their dividends in the mail via cheques. With the advancement of technology, dividends are most commonly deposited into a shareholder’s bank account directly. A dividend voucher will still arrive by mail with more information on your dividend income.
Dividend Income Investing
I have tried timing the market and listened to all forms of ‘inside information’ and ‘tips’ from ill informed investors and let me quote Peter Lynch on this – “Behind every stock is a company. Find out what it’s doing.” Do not invest on hearsay and rumors, when you invest in a business, know what you own, and know why you own it.
Dividend investing is one of the most popular strategies for traditional, buy-and-hold investors. Typically dividend investing involves selecting companies which feature an attractive and sustainable dividend yield.
I myself am a long term dividend investor. My purpose of investing? To have a sustainable source of passive income which would eventually cover all my needs and wants. As of today (October 2016), my dividend income per annum is RM9K. My short term goal is to achieve dividends of RM12K per annum, an average of RM1,000 per month. A summary of my dividends can be found at My Freedom Fund. Overall, dividend-focused portfolios can provide a significant source of income for all investors.
For those of you who are not convinced with the power of compounding, I leave you in the good hands of Albert Einstein’s wisdom: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
To embrace and let time and compound interest work for you, reinvesting your dividends is key. In 10 to 20 years, you will see your portfolio snowball from mere thousands to millions.
For me, the key to stock investing is your investment period, if you are not willing to own a stock for at least 10 years, do not even think about owning it for 10 minutes. If the stock market keeps you up at night, you are not investing correctly, you should be able to see your portfolio decline by 50% without becoming panic-stricken.
Thank you for reading.