Definition: Dividend investing is an investment approach of purchasing stocks that issue dividends in an effort to generate a steady stream of passive income. Companies distribute cash dividends to their shareholders periodically during their fiscal year, but most issue them on a quarterly basis.
What Does Dividend Investing Mean?
What is the definition of dividend investing? Each quarter, on the dividend declaration date, a firm’s board of directors declares the dividend amount that will be distributed to the firm’s shareholders. Only the shareholders who owned the stock on the dividend record date, i.e. the date that the firm reviews its lists to determine the shareholders of record, receive a dividend.
Shareholders who do not own the stock on the dividend record date are not entitled to receive a dividend. Likewise, investors who buy the stock on or after the ex-dividend date do not receive the firm’s dividend.
Usually, dividend investors are interested in a firm’s dividend payout ratio and dividend yield. A dividend payout ratio between 40% and 50% indicates that the firm distributes almost half of its retained earnings to its shareholders while the remaining is invested in the launch of a new product or to lower the short-term debt. The dividend yield may lead to a large cash income.
Let’s look at an example.
Example
A steel manufacturing firm has released its quarterly results and has a net income of $250 million. The board of directors decides to pay $120 million in cash dividend and reinvest $130 million in lowering its short-term debt. This means that the firm’s dividend payout ratio is dividend / net income = $120 million / $250 million = 48%.
The board of directors declares a quarterly dividend of $0.95 per share, reaching an annualized dividend of $3.8 per share. The stock currently trades at $88; therefore, the dividend yield of the stock is dividend / stock price = $3.8 / $88 = 4.32%. A shareholder that holds 10,000 shares will be compensated with 10,000 x 4.32% = $432.
On the ex-dividend date, the stock price declines to adjust to the dividend paid. Therefore, the firm’s stock that trades at $88, and pays a quarterly dividend of $0.95 per share, ceteris paribus, the stock will open at $88 – $0.97 = $87.03 on the ex-dividend date.
Summary Definition
Define Dividend Investing: Dividend investing is an investor strategy of only buying stocks that issue dividends thus creating a reoccurring income stream.
