Collection: Peter Lynch - #46 'What is a Dividend?'



Dividends are cash payments the companies make to the shareholders, usually every quarter. Nearly half the return the S&P 500 over the past 50 years has come from dividends. Dividends come from profits. If a company earns five dollars a share, they have the choice of paying out some of it to the shareholders in a form of a cash dividend.

A stock’s yield is the annual dividend payout divided by its current price. The yield is the return you get on your investment every year. One drawback – The IRS considers dividends as income. So, you have to pay taxes on dividends.

Not all companies pay a dividend. Fast growers for example, almost never pay a dividend. They reinvest all of their earnings back into the company. Slow growers tend to pay out profits in dividends. It is their way of rewarding shareholders.

Over time those dividends can add up. Some people have bought stocks for $5 a share and 20 years later they are getting $10 a share of dividends per year. Dividends do make a difference.

Dividends are a great way to measure a company’s success, particularly a slow growing company. When a company raises its dividend every year, it raises the bar for its financial performance for the years that follow.

Few companies want to cut their dividends. Investors clobber the stock, figuring a dividend cut is a sign of worse things to come. So, by raising a dividend 12 to 15% this year, the company is saying it expects earnings to be at least as good next year as they are now and probably rising by at least to 12 to 15%.

You can get a list of companies that raise their dividends many years in a row from Moody’s. There are some great names in this list. However, you can find warning signs in the dividends as well.

A high yield isn’t always a good thing. If a stock is $30 and it is paying a $3 dividend, you might say wow that’s terrific. A 10% yield. But if the earnings are only $3.10 a share, then the company is essentially paying out all of its earnings in dividends. That is only ten cents to expand or to invest in more efficient equipment.

If this continues for a number of quarters or years, the company will have very little room for any errors or setbacks. Eventually, the company will probably cut back or totally suspend its dividend. The stock price is going to tumble with it.

Be careful with high-yield stocks, particularly when they are paying out a very high percentage of their earnings.



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