Dividend stocks are a useful way to earn an income when investing and get your share of company profits. Typically, companies that pay dividends aim for stability, so they tend to be blue-chip stocks as well, but not always.
Buying dividend stocks for your investment portfolio could give you some extra diversification and a chance to benefit from compounding. Here’s how to invest in dividend stocks, what to look at when comparing shares and what to consider first.
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You can check with your share dealing provider when to expect dividends from the companies you have invested in. They may show this information with the other company financials or have a dividend calendar.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
The size of the dividend you will receive is determined by the company’s performance and the number of shares you have. Dividends are usually calculated as a percentage of a company’s profit (earnings), known as the “dividend payout ratio”.
The dividend payment you receive is calculated using the number of shares you own. For example, if you own 5,000 shares in Company XYZ, which is paying a dividend of 5 pence per share, you will receive a payment of £250.
Dividend yield is another measure that compares the dividend payout against the current share price as a percentage. It works out exactly the same in the case of fractional shares (which are smaller pieces of whole shares).
A company’s board of directors will decide when to pay a dividend and how much to pay. While they are usually issued as cash payments, dividends can also be offered in other forms, for example, as additional shares in the company.
Dividends can only be paid from a company’s profits for the current year or profits it has retained from previous financial years.
Dividend yield is the amount that a company pays in dividends relative to the market value of one share. It’s worked out by dividing the dividend per share by the share price and multiplying it by 100.
This is a nice way to compare the dividends that companies pay, but as stock prices change all the time, this does, too.
This is simply a name used for a company that pays dividends. If an investor says they dedicate some of their portfolio to dividend stocks, then they’re generally investing in companies that tend to pay out some of their profits to their shareholders as income.
When you own shares in a company, you own a piece of the business. Companies don’t have to pay dividends, as they can choose to reinvest the money into the business for growth. But ones that do so regularly will become known as dividend stocks and tend to be popular with investors looking for income.
Dividend stocks can make money for shareholders in 2 ways:
Dividend payments are usually made every quarter (4 times a year), although some shares pay out just once or twice per year. Of course, dividend payment amounts and schedules can vary. And dividend payments are never guaranteed.
It’s also worth noting that some companies do not pay dividends at all. For example, a new company might plough all its profit back into the business to fuel growth.
There are some pros and cons to buying dividend stocks, here’s some of the main ones:
There are a number of factors to consider when comparing which dividend stocks (dividend-paying shares) to buy:
You need to own the share before the ex-dividend date to receive the dividend. It’s worth knowing the process and key dates:
Finder’s investment expert Zoe Stabler answers
Yes, but it’s not as simple as investing, getting a payout and selling. Typically, on the ex-dividend date, the stock will be trading at a lower price. This is theoretically at a discount of the dividend amount, but this isn’t always the case.
This means that while you could buy the stock and get the dividend, you’ll need to wait for the stock to return to its original position (or rise further if you paid fees to make the trade) before you sell it — it’s not a quick win or easy money. There is an investment strategy that uses this idea, but a lot of analysts and experts don’t believe that it works.
Dividend capture is a type of investment strategy that does exactly this. It’s often a day trading strategy as it involves trying to time the market. Investors who use this strategy will make use of a dividend calendar and choose to purchase stocks with large dividends.
With this strategy, investors purchase shares just before the ex-dividend date, which means they are recorded on the record date as a shareholder. Once they receive the dividend, they sell the shares. This could involve holding the shares for as little as one day.
The main drawback of the dividend capture strategy is that the share price often falls after a dividend, so you’re likely to make a loss on your investment, even once you’ve considered the dividend.
In the UK, you get a dividend allowance of £500 each financial year, which means you don’t need to pay tax on any dividend income up to that amount.
If you earn more than £500 from dividend payouts then how much tax you’re liable for depends on whether you’re a basic, higher or additional rate income tax payer in your normal day-to-day job.
These are the tax rates payable on dividends over the £500 allowance – if your dividend profit takes you into a new income tax band, you’ll need to consider this.
Get more detailed information on how dividend tax works
Some companies offer investors a dividend reinvestment plan (DRIP). If you opt in, this allows you to use your dividends to buy more shares in that company instead of receiving the dividend payment in cash.
One of the main advantages of doing this is that you can buy extra shares without paying any more brokerage fees to your platform. It’s also a good way to increase your holdings in a company over time with little or no active effort on your part! Your dividends can earn their own dividends once they equal one share.
A downside of signing up for a DRIP is that you don’t receive a traditional dividend payout in cash, so you won’t have that as a form of regular income. You also don’t get to choose at what share price you buy the additional shares – they’re automatically purchased on your behalf on the dividend payment date. Also, you sometimes have to sign up directly with a company (rather than a brokerage).
One issue to be wary of is investing in a company based solely on its history of dividend payments. Just because a company pays a regular dividend doesn’t mean it is a safe and stable investment, so do plenty of research before handing over your money.
It’s also vital that you research the whole company and it’s financial performance, don’t get stuck in the weeds of all the dividend data. If the stock drops in value, that negatvitity could outwiegh the benefit of getting a dividen payment.
Investing in companies that pay dividends can be a smart move. Payments aren’t guaranteed, but they can be an excellent wealth-building tool. Keep your eyes peeled for any possible taxes, using a stocks and shares ISA is the best way to simplify your tax situation when investing in dividend stocks.
Remember, dividends have traditionally played a key role in wealth building, contributing about a third of total stock returns over the last 100 years. However, the lion’s share of returns, about two-thirds, has come from share prices going up – this reflects the trade-off between companies paying out profits to shareholders and reinvesting those profits to grow and increase their stock price. It’s about striking the right balance for your investment strategy.
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