What is dividend investing?

Wall St. Nerd


Updated on

January 13, 2023


What is dividend? The term dividend is well known and widely used in the investment world. Nevertheless, it is a rather difficult and elaborate phenomenon. There is a lot involved, so do not underestimate it.


What is dividend investing?

Dividend is the payment of a portion of the income of a company. In simple terms, it is a kind of profit distribution. In other words, part of the profits of the company in question are distributed among a certain group of shareholders.

The word dividend comes from the Latin word 'dividere', which means to distribute. In many cases, the dividend is determined by means of a fixed percentage of the profit. It is also possible that this percentage fluctuates with the performance of the company. Therefore, there is no fixed way of paying out dividends, nor is there a fixed amount. When a company has made less profit during a certain period, this will influence the dividend payment. This will be explained later.

To answer the question, what is dividend investing? Dividend investing is investing in stocks that periodically pay dividends to the shareholders. However, when you own a stock, it does not immediately mean that you will receive a dividend. In general, there are a number of companies that pay out a percentage of the profits. They are often from the same kind of industries. Companies that are known to pay dividends mainly come from the following sectors:

  • Basic materials
  • Oil and gas
  • Banks and other financial institutions
  • Health care and pharmaceuticals

Dividend stocks do not necessarily have to come from one of the above sectors. You can also follow entire sectors using, for example, dividend ETFs.

Why do companies pay dividends?

It sounds a bit strange that a company just gives you extra money. This does not happen with normal shares, so why now? When you just start investing, it is logical to think that you will make a profit when your shares go up. This is how you initially want to achieve returns. Very briefly, this is the game, you might think. Companies pay out part of the profits because they want to reward the shareholders.

Certainty. This also makes it more attractive to invest in this share. Dividends provide security for investors. In addition, it says something about the confidentiality of the company. When a company can pay out dividends, it means that the company is making a healthy profit. The company also tries to give a message to the investor, namely that they expect to continue making profits in the future.

Image. Historical data also shows that companies that pay higher dividends are generally among the more stable companies. This is widely known among the more committed investors. Therefore, it is also a form of marketing aimed at these investors. Yet, there are plenty of people who disagree with the above statements. Some investors believe that every company pays out profits, only in a different way than you might think.

Indirect profit. For example, many companies reinvest the part of the profit (which in other companies would be paid out in the form of dividends) back into the company in order to achieve internal growth. When a company grows, the value of its shares increases. The shareholders therefore benefit indirectly from this. This gives another dimension to the question; what is dividend investing?

How does dividend investing work?

What is dividend and how is it determined by a company?

It is logical that investors with more shares also receive a larger amount in dividends. So the dividend payment is based on the amount of shares the investor has in the company. However, there are also different ways to pay out dividends. Globally, three methods can be distinguished.

This gives an idea of how dividends work from the perspective of the company. This makes it easier for you to answer the question: what exactly is dividend investing?

Residual dividend policy. For example, there are companies that have a 'residual dividend policy'. This is called a residual dividend. This means that the company counts on the internally generated capital for upcoming projects. No profit remains; the profit is paid out to shareholders or reinvested in the company.

Stable dividend policy. There is also a policy called 'stable dividend policy'. The name actually speaks for itself. These companies pay out a percentage of the profits on a stable and consistent basis. Forecasting long-term earnings determine the amount of dividend paid. Of course, this prediction also takes into account the recent profits. The main advantage of this dividend policy is to create a sense of security among shareholders.

Hybrid policy. A hybrid policy also exists. This means combining the two ways of paying dividends mentioned above. It is a popular way of paying dividends among companies. With this method, a part of the profit is represented in the dividend percentage. It also ensures a certain degree of security for the holders of shares to keep a fixed factor within the dividend provision.

By the way, you can invest in dividend stocks, ETFs and funds. It is a form of investment that is mainly used to generate passive income. Passive income generation with dividends is very common, especially for investors with a broad investment horizon.

Which shareholders receive dividends?

Companies that distribute profits do not pay this amount to all shareholders. A certain group is entitled to dividends, which is important to know when investing in dividends. It is important to check whether you would qualify for this, should you consider buying dividend stocks.

What is dividend investing? To be able to answer this question, and specifically this part, there are some terms and concepts that are useful to know. To be able to tell when you are entitled to a piece of the profits, it is important to know the term 'ex dividend'.

In short, an 'ex-dividend share' is a share for which you are no longer entitled to the profit distribution of the past period. The length of this period differs per company. The company sets a specific day. This is called the 'record date'. If you are a direct shareholder of the company no later than three days before this date, you are entitled to dividends. Logically, this record date is not announced far in advance, to prevent abuse.

A dividend calendar keeps you informed of the ex-dividend date, among other things.

Thinking mistakes

Despite the fact that dividends are a well-known concept, there are still some common mistakes when it comes to dividend investing. If one asks oneself 'what is dividend?’ the first thought is simply a percentage you receive when you own a stock. A logical next thought is that a dividend stock with the highest dividend pay out is also the most interesting for an investor.

Internal growth. However, this is not always the case with dividend investing. A share with a high-intended dividend yield is not always a good sign. Firstly, the company pays out a relatively large proportion of its profits to its shareholders. This also means that the company has less money left over to invest in internal growth. This is the case; for example, when the higher published dividend yield does not attract the desired number of additional investors.

Risk. Because this, of course, is also an important aspect. Going back for a moment, what exactly is dividend? A share of the profit, but also a way of marketing to make buying a share attractive. You could ask yourself why this is necessary. If a company is doing well and has a bright future, the share sells itself. It is therefore important to think carefully about this too. A high dividend yield sounds good, of course, but you should take into account the risk you are taking.

"Dividend investing is boring".

Boring. In addition, companies that pay out a percentage of the profits are starting to develop a kind of boring image. When you start investing at a relatively young age, you are often looking for a bit of excitement. However, dividend stocks can also be quite exciting. Dividend ratios can also fluctuate, which is something you can take advantage of.

Rising dividend ratio. Stocks that currently generate a rather low dividend yield may well have a higher ratio in the near future. This can happen, for example, if the company in question has a relatively high free cash flow available. This also makes the stock more attractive to other dividend investors, which in turn can make your stock rise in value. Anything but boring.

Safe. This brings us to the next misconception about dividend stocks. It is a common assumption that dividend investing is safe. However, this is by no means always the case. As mentioned, a high dividend ratio can also be a cry for help. A last convulsion of a company that quickly needs a large number of investors. Fortunately, in most cases this is not the case. Companies that offer high yield ratios are in many cases simply strong companies, with a bright future ahead of them.

What is involved in dividend investing?

What terms are important to know?

In this article, we have already come across some interesting terms and concepts. If we go back to one of the main question of this article, what is dividend?, we can conclude that there is a lot involved in answering this question. In order to understand the explanation, some terms are important. The most important terms are briefly listed here.

  • We have already seen the term ex-dividend. This term goes hand in hand with the already mentioned record date. The ex-dividend of a share also has an effect on the price of this share. The dividend paid out is deducted from the value of the share. This is exactly the reason why some experts claim that everybody gets dividends, only some indirectly.
  • There are also different forms in which dividends can be paid. So we end up with the terms cash dividend, stock dividend and interim dividend. Cash dividend would be seen as the most obvious form for beginning investors. This means that an amount is simply paid out in the form of money. When we talk about stock dividend, we are talking about a dividend payment in the form of shares. Interim dividend means that the shareholder gets an advance payment on the final yield.
  • The term dividend ratio has also been used several times. In short, dividend ratio or dividend percentage is the part of the net profit that will be paid out to the shareholders. It is also called the pay out ratio. The term is often confused with another term, called dividend yield. Of course, this dividend yield is achieved when investing in a dividend stock.
  • Also the term unpaid dividend is important to keep in mind. It also happens that dividends are not paid. Of course, the shareholder is entitled to this, given the fact that at the time of the transaction, an agreement was made between the company and the investor. The reason that unpaid dividends exist is that there is a difference in time between the record date and the actual date that the dividend is paid out.
  • Also important are the differences between growth and high dividend stocks.

How does dividend investing work in practice?

Frequently asked questions about dividend investing are addressed briefly in the following text.

It is important to know these principles so you can anticipate them in practice.

What are the best dividend stocks?

As mentioned, the best dividend stocks are not necessarily the companies that offer the highest dividends. It is important to consider what is important to you, and what investment strategy you use. We would like to give you some good examples. For your inspiration, we have made a list of the best dividend stocks. We will tell you why we think these are good options, so you can decide which dividend stock is best for you!

(Finbox is a good tool to filter the best dividend stocks for your portfolio)

What is a dividend pay out?

Dividend pay out is the distribution of a portion of profits to shareholders. As mentioned, this can seem desperate. On the other hand, and this is usually the case, it is a sign of confidence in the future. In the case of smaller companies, paying out dividends can also be more advantageous than paying out a regular salary, so this can also be of interest to entrepreneurs.

When is a dividend paid?

Dividends are paid out when a company has many cash in circulation. This means that the company is generating good profits. The payment of dividends is determined on the ex-dividend date. A period of unpaid dividend then follows, in the end the dividend will be paid out to the rightful owner.

How is the dividend paid out?

Dividends can be paid using either the cash dividend or the stock dividend method. This means that the dividend can be paid out in cash. In that case, you will receive an additional amount of money on your account at the broker where you trade. It is important to take a good look at the type of broker you choose. For dividend investors, other brokers might be more advantageous. Logically, the dividend in the form of shares will also be added to the investor account at your broker.

How much dividend will I get? What is dividend per share?

The amount of dividend you will receive varies every year. The amount of dividend you will receive depends for a large part on the profits. Companies that pay out many dividends are also quite popular. The dividend per share is the amount of dividend you will receive on one share. A pay out ratio determines the dividend per share. This is the percentage of the company's profit that is paid out to the shareholders. Of course, the percentage differs per company, but in many cases, it is above 50% of the profit. There are also different types of dividend ratios that can be divided into 3 different categories.

  • Low dividend ratio

These are companies with a dividend ratio of less than 2%.

  • Medium dividend ratio

Companies with a dividend ratio of 2-4% fall into this category.

  • High dividend ratio

These are companies with a dividend ratio of 4%+.

How often can you pay out dividends?

What is a dividend if you do not know when you will get it? In principle, the company itself determines how often it pays out dividends. It is rare, but there are companies that pay out a weekly dividend. It also happens that a dividend is paid once a year. In general, it is customary to pay dividends once every quarter.

What can I get out of dividend investing?

As with any form of investing, the return is entirely in your hands. Investing in dividend stocks can be very profitable, provided it is done right. Two factors are specifically important for dividend investors. Both have to do with the interest on interest effect. When a company pays high dividends, the internal interest-on-interest effect is reduced. Therefore, this is not favourable for the growth of the company.

On the other hand, the investor receives payments that are more direct. Therefore, the external interest-on-interest effect is more favourable for dividend investors. However, the payment of dividends does have an effect on the value of the share.

How does a dividend payment affect the share price?

What is a dividend? The payment of a portion of the profits of a company, in most cases. What is a price? The determination of a price depends on supply and demand, which in turn depends on the performance and thus the profits of a company. When dividends are paid out, a bite is taken out of the value of the share.

It often happens that the percentage of the dividend that is paid out is about the same as the percentage by which the share drops the day after the payment at the opening of the stock exchange. This is also the reason why some experts say that everybody gets dividends, only that in case of regular stocks, it is reinvested back into the company.

Is dividend investing a valid strategy for me?

People are increasingly investing in dividend investment products when savings rates are low. This has been the case on several occasions. So many people see it as a good alternative for saving! To determine whether dividend investing is a valid investment strategy for you, there are a few factors you need to determine first.

For example, think about how much time you can spend investing each month. This is linked to the choice of whether you prefer active or passive investing. There are also some other factors that are important. Dividend investing can be a lucrative passive strategy, so it is suitable for many investors!

ETFs and dividend investing

Especially when investing with little money, investing in ETFs is a good option. There are many good trackers that generate a nice return. When investing in an ETF, you do not need a large initial capital. With a low threshold, you can achieve a risk spread of 500 companies.

There are many ETFs; they follow a certain group of companies or companies in a certain sector. So there is something for everyone, including dividend investors.

How does dividend pay out work in dividend ETFs?

There is a lot of confusion about dividends in combination with an ETF. It is definitely the intention that an investor in an ETF simply receives the dividend. Therefore, when a company pays a dividend in a tracker, the holder of an ETF will also receive it.

However, this does not mean that dividend-paying ETFs are more profitable. Dividend-paying ETFs also have an impact on share prices.

Conclusion - You are the master of your dividend investing strategy

Instead of engaging in fruitless fundamental discussions about the sense and nonsense of dividend investing, think about which investment strategy suits you best and choose your shares accordingly. You are also welcome to choose a share that does not pay a dividend. Just do not get caught by a dividend investing enthusiast!

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Hi, I'm Alexander Kelm.

Serial entrepreneur, value investor and angel investor. Founder of Wall St. Nerd. Join me here on wallstnerd.com to learn how to read financial statements, find healthy companies, and invest your money wisely.

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