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Dividend investing is one of the best ways to grow your wealth as it gives you two types of income. One is the appreciation in the stock price, and the second is income from dividend payments. If you check the performance of dividend stocks, they have shown less volatility than others.
In 2022, dividend stocks showed resilience when the price of most stocks tumbled on the back of negative news like the Russia-Ukraine war, the high inflation crisis, etc. In 2023, when the global economy stands at the edge of another recession risk, investing in dividend stocks seems more profitable. They are expected to perform better than other stocks as they are fundamentally strong companies.
This article will discuss the basics of dividend investing and the 6 best dividend stocks for 2023.
Dividend Meaning
Companies pay a part of their profit to shareholders, and it’s called the dividend. Typically, dividends are paid either in the form of cash or shares. Though companies can pay dividends at any time, they usually pay them quarterly, semiannually or annually. In the United States, most companies pay dividends in the form of cash.
In the U.S., dividends are declared on a per-share basis. For instance, you hold 100 shares of a company, and it declares an annual dividend of $0.30 per share. Here, you’ll receive $30 in cash dividends. Instead of cash dividends, if the company issues stock dividends at 10%, you will have 110 shares of the company after the dividend issue.
While investing in dividend stocks, you must know that companies are not obliged to pay dividends. Whether to pay dividends in a financial year/quarter or how much to pay per share depends totally on the decision of the company’s board of directors. They take this decision depending on the company’s profitability and business outlook.
Key Terms You Should Know About Dividend Investing
Dividend yield: Dividend yield is also known as the dividend-price ratio, which indicates how much the company pays as dividends in a year with respect to its share price. The dividend yield is computed by dividing the annual dividend per share by its current market price. Usually, the dividend yield is expressed in percentage; hence a higher value is better. At the same time, a sharp increase in the divide yield in a short period is not a good sign. So, before investing in the shares of such companies, you should check whether it’s due to a steep decline in the share price or any other reasons.
Dividend payout ratio: The dividend payout ratio indicates how much of the company’s net income is paid out as dividends, and it’s calculated by dividing the dividend per share by the company’s net income. A low dividend payout ratio indicates that the company is paying less as dividends and reinvesting more into its business. On the other hand, a high dividend payout ratio shows the company is paying out a large part of its earnings as dividends. Shares of companies with low dividend payout ratios are suitable for growth investors, while that of a higher value are good for income investors. Click here to know which strategy is more apt for you.
Record date: On the record date, the company decides and finalizes the list of eligible shareholders for its upcoming dividend distribution. Generally, the board of directors selects the record date. The record date is also known as the date of record.
Ex-dividend date: The ex-dividend date or ex-date is the cut-off date for the upcoming dividend distribution, i.e., if you buy the shares of a company on the ex-date or after it, you won’t qualify to get the forthcoming dividend payment. Usually, the ex-date falls one day before the record date and is set per the stock exchange rules.
Payment date: The company credits dividends to eligible shareholders on the payment date.
How You Can Utilize Dividends
As dividends are the amount you earn on your investment, you can utilize them according to your wish. But reinvesting your dividends to buy more shares of the same company is one of the most sensible ways to use it. A few advantages of dividend reinvesting are:
- You don’t need to pay any brokerage when you use the dividend amount to buy more shares of the same company.
- Several companies offer their shares at a discounted price for their dividend reinvestment plans.
- Dividend reinvestment is a better way to take advantage of dollar-cost averaging and grow your wealth swiftly.
Factors You Should Consider While Investing In Dividend Stocks
Indeed, dividend investing is a better strategy for growing your money. But before putting your money into a dividend stock, you should understand a few more points about dividend investing.
- Avoid investing in stocks only based on dividend yield. Check the fundamentals of the company before investing in it.
- Compare the dividend yield of the company with its peers. If it’s significantly high compared to others, it’s a trap. So, avoid that company.
- Also, avoid new companies that pay extraordinarily high returns. It’s a way to attract investors, and there is no guarantee that the company will be able to payout dividends at the same level in future. Hence, always check the future growth potential before investing in new companies.
- If the outlook of the business of a company or its industry is bleak, avoid investing in it. Chances are high that the company can reduce the dividend in the future.
Tax On Dividends
You need to pay tax on dividends you receive from your investments in shares of a company. The rate at which they’ll be taxed depends on which category your dividends fall into, qualified or non-qualified.