A Beginner’s Guide to Dividend Stocks

This was originally posted on Planner Bee.

Investing in dividend stocks can be a great way to build wealth and generate passive income. However, for beginners, diving into dividend investing can be intimidating, especially given the stock market’s complexity, abundance of jargons, and ever-changing trends.

Grasping the fundamentals can empower you to make informed decisions. This guide will walk you through what dividend stocks are, how they work, and how to start investing in them.

What are dividends?

Dividends are a portion of a company’s profits that are paid out to shareholders on a regular basis. They are typically paid quarterly, but some companies may pay them annually or semi-annually.

Such payments are usually distributed in cash but can also take other forms. Here are some of the common types of dividends:

1. Cash dividends: The most common type, where companies distribute a portion of their earnings in cash directly to shareholders.
2. Stock dividends: Instead of cash, shareholders receive additional shares of the company’s stock.
3. Special dividends: One-time payments made by companies. They are often larger than regular dividends and usually come from exceptional profits or asset sales.

How are dividends calculated?

Dividends are calculated based on the number of shares owned by a shareholder and the dividend per share declared by the company.

For example, if a company declares a dividend of S$2 per share and you own 100 shares, your dividend payment would be S$200 (100 shares x S$2 per share).

Knowing this calculation can help you understand the income that you can expect to receive from your investments.

Why invest in dividend stocks?

Here are a few reasons why dividend stocks can be attractive, especially for beginners:

1. Regular income

Dividend stocks provide a predictable income stream, which can be particularly appealing to retirees or those seeking passive income. This income can be reinvested to purchase more shares or used for other purposes.

2. Potential for capital appreciation

While dividends provide immediate returns, dividend-paying companies can also experience stock price growth, contributing to overall portfolio gains. This dual benefit of receiving income while also potentially enjoying capital appreciation makes dividend stocks a versatile addition to any investment strategy.

3. Compounding returns

Reinvesting dividends can lead to compounding returns over time. By purchasing more shares with the dividends received, you increase the number of shares you own, which in turn generates more dividends, creating a snowball effect.

Read more: Investment Portfolio Basics: What is it, and How to Build One?

How to start investing in dividend stocks

1. Research and choose dividend stocks

Make sure to do your own research and look for companies with a consistent history of paying and increasing dividends.

Key metrics to consider include:

• Dividend yield: This refers to the annual dividend payment divided by the stock’s current price. A higher yield indicates a higher return on investment. However, be cautious of yields that are significantly higher than average, as they may hint at underlying issues with the company.
• Company fundamentals: Analyse the company’s financial health, competitive advantage, and future growth prospects. A strong company with a sustainable dividend is ideal.
• Payout ratio: The percentage of earnings paid out as dividends. A lower payout ratio suggests that the company retains enough earnings to reinvest and grow.
• Dividend growth rate: The rate at which a company’s dividend payments have increased over time. Consistent growth can be a sign of a healthy, expanding business.
• Track records: Look out for companies with a long history of paying and increasing dividends. A strong track record indicates reliability and the potential for sustained future payouts.

Apart from the above metrics, it is also beneficial to consider the industry’s overall health and its impact on dividend sustainability. Some sectors, like utilities and consumer staples, have a history of reliable dividends.

2. Start small

Begin with a manageable amount you can afford to invest for the long term. This initial investment shouldn’t disrupt your financial security or affect your existing emergency savings.

Starting small allows you to learn the ropes of dividend investing, build confidence in your strategy, and reinvest your dividends to accelerate your portfolio’s growth through compounding.

3. Diversify your portfolio

Don’t put all your eggs in one basket.

Practising portfolio diversification can help you mitigate risk by spreading investments across various sectors and industries. This reduces the impact of poor performance from any single stock on your overall portfolio.

4. Monitor and review your investments

Regularly review your dividend stocks to ensure they continue to meet your investment goals. While you keep track of dividend payments, look out for any changes in company performance and overall market conditions.

Read more: A Guide to Regular Savings Plans in Singapore

Important dividend dates to know

Here are some key dates to be aware of to help you determine dividend eligibility and payment schedules.

• Declaration date: This is the date when a company’s board of directors announces their intention to pay a dividend. On this date, the company also declares the amount of the dividend, the record date, and the payment date.
• Ex-dividend date: The ex-dividend date is critical for determining dividend eligibility. To receive the declared dividend, you must own the stock before the ex-dividend date. If you purchase the stock on or after this date, you will not be entitled to the upcoming dividend.
• Record date: The record date is the cutoff date set by the company to determine which shareholders are eligible to receive the dividend. Only shareholders who are recorded on the company’s books as of this date will receive the dividend payment.
• Payment date: This is the date when the dividend is actually paid to eligible shareholders. On the payment date, the company distributes the dividend, either in cash or additional shares, depending on the type of dividend declared.

Knowing these important dividend dates can help you plan your stock purchases and sales more effectively, ensuring they capture the dividend payments you are entitled to.

Risks and considerations

Like any other form of investment, dividend stocks come with their own set of risks and considerations. It’s important to be aware of these potential downsides to make well-informed investment decisions.

1. Dividend cuts

Companies can reduce or eliminate dividends due to financial difficulties.

Monitoring a company’s financial health and payout ratio can help anticipate potential dividend cuts. Staying updated with the company’s earnings reports and industry trends allows you to spot early warning signs.

2. Market risk

Like all stocks, dividend stocks are subject to market risk.

Economic downturns, market volatility, and changes in interest rates can impact stock prices and dividend payments, which highlights the importance of diversification.

3. Inflation risk

Inflation can erode the purchasing power of dividend payments.

Investing in companies with a history of dividend growth can help mitigate this risk, as increasing dividends can outpace inflation. Selecting companies with strong pricing power and consistent revenue growth can minimise inflation risk.

4. Interest rate risk

Rising interest rates can make dividend stocks less attractive compared to fixed-income investments like bonds.

This can lead to decreased demand and lower stock prices for dividend-paying companies. Keeping an eye on interest rate trends and economic forecasts can help you adjust your investment strategy accordingly.

Closing note

Investing in dividend stocks can be a rewarding strategy for generating passive income and achieving long-term financial goals.

By understanding the basics of dividend stocks, researching and selecting quality companies, and managing risks through diversification and regular review, beginners can build a solid foundation for their investment portfolio.

Stay informed about market conditions and adjust your strategy as needed to optimise returns and minimise risks. With patience and diligence, dividend investing can be a powerful tool in your financial arsenal.