Can You Get Rich With Companies That Pay Dividends?

Can you get rich with companies that pay dividends?

What do you want from your investments? You would obviously say “Good Returns”. You are ready to risk your money in stocks though it is a volatile asset. It is because you know that some companies would give steady income to investors. They have consistently given back a significant amount of their net profits to shareholders in the form of dividends and such Stocks attract huge number of investors. Let us see what are dividends and analyse the fact why companies pay dividends or not, how they do so and does the dividend policy of the company help the investor.

What are Dividends?

Dividends are corporate earnings that companies pass on to their shareholders. Some companies pay dividends and some do not but prefer to reinvest all of its earnings back into the company.

A growing newbie company usually won’t pay dividends, because it wants to invest as much as possible into further growth. Even a mature one that believes it will do a better job of increasing its by reinvesting its earnings will choose not to pay dividends.

Also, the choice to not pay dividends may be more beneficial to investors from a tax perspective. Dividends are taxable to investors as ordinary income, which means an investor’s tax rate on dividends is the same as his marginal tax rate that can be high or low.

Investors also see a dividend payment as a sign of a company’s strength and a sign that management has positive expectations for future earnings, which again makes the stock more attractive. A greater demand for a company’s stock will increase its price.

Are Dividends popular?

To some people Dividends are not so popular, but they play a significant role and should not be underestimated. While capital gains help investors and so does dividends that provide cash flow that locks in returns. Over the past years, investors have enjoyed record dividend payments from the world’s largest companies. Companies like Microsoft paid dividends up to $9.49 billion with payout ratio of 40.7 % rewarding shareholders with consistent dividends. The company has been increasing its annual dividend for more than a decade. Last year in March, Microsoft declared a quarterly dividend of 31 cents per share.

Microsoft dividend chart

If we look at the example of the company Apple it paid dividends more than $11.16 billons with payout ratio: 28.1%. This  world’s largest publicly traded company is a big fan of dividends and share repurchases. Apple is the second biggest dividend payer, with shares yielding nearly 1.5%. In 2015, the company return over $130 billion to shareholders  up from its previous $100 billion plan. Apple also raised its share repurchase program to $90 billion from $60 billion, and hiked its dividend by 8%. Overall, Apple has the largest shareholder return program in history, and is continually expanding

Apple Dividend Chart

There was a time (1976) when for some reasons dividends fell out of fashion in the United States but the amounts now being paid out in dividends mean the stocks that pay them are once again in big demand. Dividends are capitalism at its best and it’s hard to believe they ever went out of fashion in a place with the instincts of the United States.

A report by Henderson Global Investors in 2014  stated  that between 2009 and 2013, the world’s public companies paid about $4.4 trillion in dividends only.

Warren Buffett’s Top 10 Dividend-Paying Stocks for 2015

So that shows that companies do shower shareholders with money Dividends and are so popular among many companies like the S&P 500 that 421 companies of such kind paid dividends over the trailing months, representing 84% of the index. Interestingly, 341 companies also increased their dividend payments during this time.

Does dividends affect stockholders?

Some financial analysis believe that the dividend policy of a company does not matter because investors have the ability to create “homemade” dividends. This income is achieved by individuals adjusting their personal portfolios to reflect their own preferences. Like investors looking for a steady income stream are more likely to invest in bonds where interest payments don’t change, rather than a dividend-paying stock where value can fluctuate. Because their interest payments won’t change, those who own bonds don’t care about a particular company’s dividend policy.

Also the analyst believe that little to no dividend payout is more favorable for investors. Their theory is that taxation on a dividend is higher than on a capital gain. They think that it is better to reinvests funds rather than paying them out as dividends and this will increase the value of the firm as a whole and, consequently, increase the market value of the stock. Thus they report that a company should undertake more projects, repurchase their shares, acquiring new companies and profitable assets, and reinvesting in financial assets.

But the analysis that is best in favour is the idea that a high dividend payout is important for investors because dividends provide certainty about the company’s financial well-being.

  • Dividends are attractive for investors looking to secure current income
  • The decrease and increase of a dividend distribution can affect the price of a security.
  • Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions.
  • These companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends.
  • Companies without a dividend history are generally viewed favourable when they declare new dividends.

What are the Dividend Paying Methods?

If the company therefore decides to follow a high or low dividend method they follow to use one of three main approaches: residual, stability or a hybrid compromise between the two.

Residual Method

Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. The dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. Such companies attempt to maintain balance in their debt/equity ratios before making any dividend distributions and they decide on dividends only if there is enough money left over after all operating and expansion expenses are met.

Stability Method

The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. With the stability policy, companies set dividends at a fixed fraction of quarterly earnings, choosing a stable policy whereby quarterly dividends are set at a fraction of yearly earnings. This  policy aim is to reduce uncertainty for investors and to provide them with income. Companies following this policy are always attempting to share earnings with shareholders rather than searching for projects in which to invest excess cash.

Hybrid Method

Hybrid approach combines the residual and stable dividend policies. Using this approach, companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. In today’s markets, this approach is commonly used by companies that pay dividends. Because these companies generally experience business cycle fluctuations, they will generally have one set dividend, which is established as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels.

Does the company need to pay dividend? It is the company to decide which method to use when paying dividend. As how profitable its dividends will be to investors and to the stable income. A company that eliminates or reduces its existing dividend payment may be viewed unfavorably and its stock price may decrease.

CFD and Dividends- How they go about?

While trading with CFD often your CFD broker should be asked about the dividends and their dates. There are three dates around dividend time that are important to you. The first is the ex-dividend date, the record date and the payment date.

As there are various charges and credits to your account while you hold an open CFD position, and the dividend adjustment is just another one of these. The actual dividend payment made by a company is usually made a few weeks after the ex-dividend date.

If you hold a long position in shares with CFDs, and held the day before the ex dividend date, then you become entitled to a payment equivalent to the amount of the dividend. Remember that you must be in the position prior to the ex-dividend date to receive the dividend. For instance if the share you controlled through a CFD went ex-dividend on Wednesday, then you will need to have bought in at least on Tuesday to earn the dividend credit.

If you are short the shares using CFDs, the situation is different as you now owe the equivalent of the dividend, and it will be debited to your account. Holding a short position is good in one way, because you get paid interest instead of paying interest on the margin as you do when you are long, but this is one place where you have an immediate apparent loss.

Thus, if you are short selling a security, like standing to gain from the position if the share price falls in value and you are short prior to the ex-dividend date, then you will owe the dividend.

Important Dividend Dates

Cum Dividend Date: This means the stock is trading with the dividend attached to it and buyers stand to receive the benefit of the dividend.

Ex Dividend Date: If the stock is acquired on the ex dividend date the buyer is not entitled to the dividend. The share must be purchased before the ex dividend date to be entitled to the dividend. This is the most important date for most CFD traders as traders have to buy the stock prior to this date to receive the dividend. That means you need to qualify for recieving the imminent divident payout, you need to be the owner of the shares before the market opens on the ex dividend date.

Record Date: This is the date that investors have to be recorded as shareholders. Since the purchase of a stock is not settled until  3 days after the stock is traded, the record date is 3 days after the ex dividend date.

Payment Date: This is the day that dividends are paid out and could be weeks after the record date. You do not need to own the share on the payment date, although it is necessary to own it on the record date. You are the owner of the stock at the moment the contract occurs regardless of when you pay. Your CFD broker must update you and be in touch with the market when dealing with your stock and shares.

With all this analysis the question that also comes to investors mind is that will the companies continue paying such high dividends in the future as well? The management policies of some of the companies require that they pay a specified portion of their profits as dividends each year. As such, shareholders can be assured of a regular and generous dividend flow from such stocks year after year. Holding on to these companies for a long time could easily make your long terms goals more beneficial and financially sound.

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