Understanding Dividends

by Stephanie Berenbaum – February 23, 2011

Some Stock Market Basics

If you are anything like most people we know (ourselves included), no matter how well educated you are,  you probably never learned the basic ins and outs of the stock market when you were growing up.  I don’t know about you, but my high school didn’t offer an ‘investing 101′ class – did yours?

So, even though you may have a foggy recollection of your grandparents mentioning something about waiting for their ‘dividend checks’ – do you know what dividends are and how they work? Here’s some quick and easy Fab & Fru info to introduce you to some of the basics of dividends – and why you should care!

Down To Earth Finance

Our attention turned to dividends the other day when we got an email from our friend Galia Gichon of Down To Earth Finance.  She was talking about why it might make sense to take a look at dividends as a way to get more from our investments. But first things first….

What Are Dividends?

In a nutshell, a dividend is an amount of a company’s earnings they pay out to investors.  When companies make money, they usually reinvest a good amount of it in the company. But many companies also set aside a portion of this money to pay out directly to investors.  This is usually expressed as dividends per share – so, for example, if you own 100 shares of X Corp, and the dividend is set at 10 cents per share per quarter, you will receive $10 as your dividend payment.  Thus, that dividend check in the mail your grandparents were waiting for …

To Pay or Not To Pay

Companies are under no obligation to pay a dividend and not all of them do.  Many newer, high growth companies choose to reinvest all profits back in the company.  Older, more mature companies may be past the high growth stages of their business – therefore these companies tend to be the ones who offer dividends.  So, even though they don’t offer the potential for high stock price appreciation, they do offer – though do not guarantee – a dividend payment to shareholders.

Get More From Your Mutual Funds

According to Galia, “…there are ways to get more from your investments, specifically income from your stock mutual funds.  The way to do this is through mutual funds that pay dividends or have yield above 1%.   The average dividend yields today range from 1-3%.  While you will not get rich, it can add a little cushion to your income and keep the possibility of your stock mutual funds appreciating as well.  This is not for the aggressive and speculative investor (which most of us are NOT).”

Widows and Orphans

You may have heard the stocks that pay dividends referred to as ‘Widow and Orphan’ stocks.  They got this moniker because they were seen as stable income providers to those who really needed the money.   Yes, many old school companies historically – and consistently -  paid a dividend and try to raise it a bit each year.  But – remember what we said before – no company is obligated to pay a dividend.  It is NOT the same things as investing in a government – backed treasury bond. And, yes, when companies are in trouble, sometimes that trusty old dividend does get cut…

Case In Point

As an example, back in December of 2000, AT&T stunned investors when it slashed it’s dividend — for the first time since its formation back in 1887!  Not only was it cutting its dividend for the first time ever, but by a LOT  – 83%!  So, shareholders expecting to receive 22 cents per share- each quarter- actually got 3.75 cents per share.  Sure, this sort of drastic cut is not the norm, but it is entirely possible.  So, like we said – you need to keep in mind that dividends are not guaranteed.

The Check’s In The Mail…

We hope this Fab & Fru financial moment has helped you understand the basics of dividends – even if it wasn’t top on your to-do list today!  Thank you to Galia for reminding us why it’s worth taking a fresh look this old stand-by!

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One Response to “Understanding Dividends”

  1. Jenn says:

    Thanks for the info!!

Any Thoughts?