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Investment basics: what is a dividend and for whom is it suitable?

Jamie Cameron
27. 8. 2022
6 min read

Last time I dealt with the biggest fundamental - what is a stock per se. Investment basics: what is a stock anyway? In that article, I made a passing reference to dividends, which I'd like to cover more in this article. I'll also try again to explain mostly things that I know gave me a hard time in the early days. It is not always the case that a person with experience realizes that a beginner can be a bit confused about other things. Let's get to it.

Dividend? It's not just "money for nothing"

What is a dividend?

Again, I'll start with some vague definition from the internet:

A dividend is the distribution of an issuer's profits to its shareholders and is determined by the company's board of directors. Dividends are often paid quarterly and can be paid in cash or reinvested in additional shares.

The dividend yield is the dividend per share and is expressed as a ratio of the dividend to the price as a percentage of the company's share price, for example 2.5%.

Ordinary shareholders of dividend-paying companies are entitled to a payment if they own shares before the ex-dividend date.

Cool, so I read this on the internet after talking about investments with a high school classmate, so fuck it 😂

So let's look at it - A dividend is the distribution of an issuer's profits to its shareholders and is determined by the company's board of directors.

So a dividend is simply the payment of money by a company to its shareholders. If I simplify it a lot: If a company has good profits, is doing well, and doesn't need to invest in itself, it takes the excess money and distributes it to the people who own its stock. The amount is then determined by the company's management. As a rule, for long-term stable companies, the dividend payment is regular and stable. There is growth, but it is relatively small. If a company suddenly jumps in dividend by a few whole percentages or, on the contrary, suspends/reduces the payment, it is necessary to be on guard.

It doesn't necessarily mean that something bad is happening in the company's fundamentals. The specific case then needs to be analysed separately. But that's another story for another time.

The dividend yield is the dividend per share and is expressed as the dividend/price ratio as a percentage of the company's share price, for example 2.5%

We're getting a bit bogged down in a combination of English and Czech here. The dividend yield is the dividend per share. That makes sense. If I have a stock that is worth $100 and its dividend yield is 5%, I get $5 for every share I own. Dividend yield is dividend yield in English. But in English, you're more likely to hear that a stock has a 5% dividend yield. It's the same thing.

Ordinary shareholders of dividend-paying companies are entitled to a payout if they own shares before the ex-dividend date.

Ordinary shareholders - that's who you're likely to be whenever you buy a share from a broker. Someone might correct me here, but I think this applies to 99% of us. So let's not address that. You are always entitled after the ex-dividend date. I would probably recommend using that term in English as well. I don't even know if we have a term for it in Czech, but ex-dividend date will be understood by everybody.

So what is it? Simply the time limit BEFORE which you must own a share to be eligible for a dividend. Let's say a company pays a dividend quarterly - so 4 times a year (which is probably the most common option). The next payout is scheduled for September 1. The ex-dividend date will therefore be given as, say, 27 August. In order to be eligible to receive the September 1 dividend, you must own the stock before August 27. If you buy it on, say, 29 August, you will not be entitled to the payout until the next quarter - so roughly 3 months from 1 September.

Who is the dividend good for?

Now the important point - is the dividend good for everyone? After all, it's money for nothing.

The answer is: Not necessarily. It depends on your strategy, your mind set and what your goal is.

If your goal is to accumulate a large sum in investments for say 15 - 20 years and then start using the dividend as a form of passive income, then yes. If you can appreciate that dividend paying companies have outperformed in the long run, then yes.

But if you want to bet on shorter investments, and try to beat the market with your skill and knowledge - shorter buys and sells - then you probably won't be interested in the dividend. It's up to you.

Here's the obligatory video explaining the dividend:

https://www.youtube.com/watch?v=wTCJfPtFvNM

DRIP

One of the most important features of dividends is that they are truly yours. The growth in the share price "on paper" at the broker is simply virtual until you make a sale. The dividend paid is truly yours - and you can do whatever you want with it. Cash it out, and take your girlfriend to lunch. Or use its power to guarantee that your next payout will be bigger and you can invite your girlfriend to lunch and a movie. That's up to you. That's meto DRIP in a nutshell. That is, dividend reinvestment. It's actually a variation of compound interest.

To give you an example - we have a $100 stock that pays a dividend of 5% per year. So at the end of the year, we have a stock worth $100 (let's ignore the movements and say it stayed at the same price). But we have added $5 of the dividend to our brokerage account. So we put it back into the same stock (this is what allows for fractional shares, which I wrote about last time, we don't have to buy the whole stock). So the next payout will not be 5% of $100, but of $105. So logically higher, and this way we do it again, again, again...well I guess we understand each other 😁

This is again for me a list of the most important points that made it difficult to get started in investing them. If anything needs to be clarified or added, feel free to throw a question in the comments. I will also be glad for tips on the next topic I should address.

If you enjoy my articles and posts, feel free to throw a follow. Thanks! 🔥

Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and a few other analyses. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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