Make it rain dividends! But wait, wtf are dividends?
A dividend is a slice of a company’s profits, which you’re entitled to if you own its shares. When you buy a company’s shares, you’re not just gambling on the price going up but you’re also owning a stake in the company. Even if that stake is just like 0.00001%, it’s still a stake!
So when a company reports their financial results at the end of each quarter (called earnings), they’ll typically also announce the amount of dividend to be paid per share. So if a company is paying out a 50-cent dividend and you own 100 shares, you’ll get to cash in a cheque for a cool $50. And all you did was purchase shares!
Sounds too good to be true. Why would a company hand out free money by paying dividends?
Good question. I like the way you think, you cynical bastard.
Let’s pretend your neighborhood drug dealer (hopefully, you don’t live in that kind of ‘hood) has collected money from investors and issued shares. Soon, his business takes off faster than a getaway car after a bank robbery, and the profits keep rolling in.
So now the dealer can look at how to invest his profits. But if none of his options make sense, then he might decide to return some of those profits to his shareholders since he doesn’t need the cash anyway. It keeps the shareholders happy by rewarding them and attracts more investors. (Or at least until his business gets busted by authorities. #thuglife)
So should I just look to invest in high yield dividend stocks?
The idea of holding dividend-paying stocks with a high dividend yield and just waiting for the cheques to arrive in the mail is naturally pretty tempting. After all, you’re making money without even breaking a sweat.
But there’s no such thing as a sure bet. A company’s dividend can be increased or decreased from year to year depending on how its business does. The company can even cut the dividend and distribute zero money, if the Shareholder’s Assembly decides so.
And as you’ve learned from Tinder, sometimes if it’s too good to be true – then it probably is. Some failing companies try to lure in more investors with high dividends. It’s not always easy to spot these. For example, Enron paid dividends until it was exposed as a fraudulent sack of shit, and its stock crashed and burned.
But that’s just, um, an extreme example – there are also plenty of healthy, established companies that pay good dividends.
And are there profitable companies that don’t pay out dividends? If so, why don’t they?
Yeah, baby. Remember that drug dealing business we talked about?
That dealer may want to invest all his profits back into the business. Sometimes that’s the only way for the organization to grow. He might have to spend money to recruit more sellers to stand on shady street corners.
Or he might simply buy out other dealers in the neighborhood. On Wall Street, they call that an acquisition. Or a hostile takeover, if there’s any resistance to the deal. (Although in this fictional ‘hood, a hostile takeover might actually involve firearms.)
This is why some investors looking for high growth stocks (as opposed to high dividend stocks) don’t mind getting zero dividends. They just want their investments to grow and in order for that to happen, the companies have to keep raking in the profits.
In fact, many large, profitable companies don’t pay dividends. Why? Because innovation costs money, duh!
Look, whether the profits get reinvested back into the company’s moneymaking machine or returned to investors as dividends – remember that those profits still belong to the shareholders. In the case of those companies, investors are just more interested in capital gains than dividends. Capital gains refer to the profit you make from the sale of any asset – like stocks.
By the way, dividends are not guaranteed. To give you an example, many companies suspended their dividends because of the coronavirus.
All views, opinions and analyzes in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.