Wednesday, August 7, 2013

The Wonderful World of DIVIDENDS: PART 1

First of all shout out to one of my readers: Ronald! Thanks for following the blog and your support.  And like I always say—if you or any of my followers have any questions about anything discussed on this blog please email me. This is a passion of mine and I am always happy to share my knowledge and learn even more myself! 

This post will be an overview as I plan to write at least one more post on the amazing world of dividends and dividend-investing.  As you may have noticed from my “earnings commentaries” I am a HUGE fan of stocks that pay dividends. I like to think of myself as an investor that puts most her money mainly in “quality” or ‘crème-of-the-crop” type of companies and thankfully, the majority of these companies pay dividends.

Some of the companies in my portfolio that pay quarterly dividends are:

KO (coca cola)
COH (Coach)
JNJ (Johnson & Johnson)
V (Visa)
CL (Colgate)
Ok so what the heck are dividends? Well when a company is well established and has money to “spare” they can choose to do one *or* ALL of the following:
1.   Give back portion of their profits back to their investors via dividends

2.   Buy back shares using said money. Buying back shares subsequently increases the price of the stock and creates value for stock holders. Why does the share price go up? Well, remember from initial posts that the world of investing and appreciation has a lot to do with supply and demand. Hence, if there are “fewer shares” (because the company “bought back” some shares) then, this decreases the supply which subsequently ups the value of the stock (this is the general idea).

3.   They may choose to invest the money back in to the corporation in order to continue its growth via research and development for new products, acquiring new companies, etc.

When it comes to dividends specifically (which is the topic of this post) you can think of it as something similar to the interest you get when you have your money in a bank with a couple of huge differences:

1.    Dividends are paid quarterly—every 3 months, instead of monthly.

2. Dividend yields are usually significantly higher than the interest you’d get from a bank. For example, with a company like MCD (McDonalds) you get $3.07 per share per year (they have a current annual yield of 3.13%) which is a lot more than the 0.01% APY an average bank would give you. If you don’t believe me, check out Chase interest and fee schedule.  I still cant believe these banks get away with giving people  0.01% annual payouts on their money! Before I go in to a rant let’s look at this example:

Let’s say you have $1,000 invested in MCD which translates in to roughly 10 shares (based on how much a share of MCD is worth today). 

This means that every year you get: 10 x 3.08= $30.80 simply for holding the stock! 

This is called “passive income” (you don’t have to do anything to get it other than hold the shares). The payment translates in to about $7.70 every 3 months.  This may not sound like a lot but is just a general example and trust me when I tell you these payments add up. Especially when you continue to add to your position which is something you should be doing in order to continue to grow your stake in a company that you believe in.
Obviously, the more money you have invested in a particular stock the more you’ll get in dividends. Also, lets say you have multiple companies in your portfolio and they each pay dividends you get to enjoy quarterly payments from all of these companies without lifting a finger. Also, remember this:

-->Dividends are paid REGARDLESS of whether the price of a stock goes up or down. It is a continuous payment which usually goes up every year! Using our McDonald's example, they have been increasing dividends at least once per year since 1977! And they even continued paying during the terrible bear market of 2008 when a lot of companies stopped paying. (Note: some companies did stop paying dividends temporarily during the financial turmoil of 2008. However, most of the quality companies that have been around for generations, and which I will discuss in future posts, continued paying dividends even during the hard times!)
--> As noted, quality companies usually increase their dividends on a yearly basis meaning every year you’ll get a little more money per share and the more shares you have the more money you’ll get.
Lets go wild and say you have $10,000 invested in MCD which translates in to about 90 shares.

90*3.08= $277.20 a year, or $69.30 every 3 months! And you can just sit back and collect this money. And lets say the price per share increases and your investment is now worth more than what you initially paid then you are getting dividends PLUS the stock price appreciation!

There is also something I like to call the "money machine" and its called DRIPS (Dividend Reinvestment Plan). Basically, every time a company pays you dividends it uses the money to buy you more shares of that same company. So, next time dividends are paid you have more shares hence, you get paid more. This is an option that you have and you have to call your online broker to set it up, usually at no charge! Otherwise, the money you get just sits in your account and you can use it as you please. Don’t you just love stocks?!

Now, lets look at how much you’ll get with $1,000 or $10,000 sitting in the bank at 0.01% interest:

With 1,000*.0001= .10 

With 10,000 *.0001= $1

And remember: that is PER YEAR. So, divide that by 12 and let me know how many pennies u are getting per month. So sad! Dont get me wrong, money sitting in a bank is safe and it serves its purpose. For example, money for an emergency fund or money you need for bills should be in the bank. However, discretionary income set aside for investing should NOT be sitting in your bank account!

So, obviously, your money works a lot harder for you when its invested in a quality company in comparison to it just sitting in a bank somewhere.  That’s one of the amazing powers of dividend investing! And let’s not even get in to the fact that while a bank is giving you back 0.01% for your money they are charging borrowers 15% and 20% and even more (simply look at the interest charge information in your next credit card statements to see the reality of it all!).

You work hard for your money and you deserve that your money works hard for you. Educate yourself! As cliché as this may sound: Knowledge is in fact power! As I read on a book by one of my "virtual mentors" Julie Stav:

"Investing can make the difference between walks in the public park for leisure and strolls along the beaches of the Bahamas".

Remember: Like everything else, investing comes with risk and stock prices fluctuate on a daily basis. So, make sure you do your research and your homework before you buy a position in any company. 

Stay tuned for a subsequent post about the companies  that are considered crème of the crop when it comes to paying dividends.

TELL ME, What are YOUR thoughts on dividend investing?

Until next time my friends!

Disclaimer: Although I hold positions in the stocks mentioned, this is not a recommendation to buy. Dont invest or cease to invest solely based on the information provided here. This blog is for educational purposes only.