An easy way to start earning passive income is by buying dividend-paying stocks. The process is simple and can be done by anyone without much financial knowledge. When starting a passive income portfolio the important thing is to start and it is easy to start buying shares with a broker. Remember that, like any investment, it carries risk. No matter how good companies / stocks you have, if the stock market falls, everything falls. (As seen with the Coronavirus).
So, What are Dividends?
An investment in stocks is like a claim on the long-term flow of cash generated by a company, or money generated by the company. There are different ways to benefit from these cash flows, the two main sources being an increase in share prices due to growth in the business, called capital appreciation, and cash distributions financed by the ongoing cash flows it generates. the business. Dividends are a form of cash distribution and represent a tangible return that can then be used for other purposes. A company that pays dividends is basically writing a check to its shareholders with the profits it generates.
For investors who use a broker, which is the majority of investors, that check will simply be a deposit that appears in your broker account. Dividends can be paid quarterly or monthly, semi-annually, annually and even on a one-off basis, in the case of special dividends. There are a few key dates to keep in mind, especially the ex-dividend date, which is the first trading day that a future dividend payment is not included in the price of a share. After the ex-dividend date, a stock is traded as if it had already paid the dividend. If you buy the shares before that date, you get the dividend. If you buy the shares after the ex-dividend date, you do not receive the dividend.
How Much Can You Earn With Dividends?
Let’s first discuss what interests everyone. How much can you earn with dividends? It depends, of course, on how much you can invest. What you earn depends on how much money you invest in a stock and the percentage of the profits that the company distributes each year. Often times you have to invest a lot to generate a significant passive income stream. You don’t want to invest $500,000 all at once either. You have to remember that if you reinvest your dividends in more shares, the money multiplies thanks to compound interest. The more you have the faster it grows.
How Are Dividends Paid?
If we use the example of “XYZ Company” and we have $1000 invested:
- In cash – You receive the dividend in your broker account in cash for a value of $27.50. (2 times a year in the case of “XYZ Company”, the total $56 / year)
- Scrip dividend – You receive new “XYZ Company” shares worth $56.
- DRIP – Allows you to use dividends to automatically buy additional shares over time. Sometimes companies offer incentives for this, such as slightly below market reinvestment prices, and these transactions will generally not incur brokerage fees. You are using the dividend to buy more shares. That’s basically dollar cost averaging, or spreading your purchases over time.
Some companies use the scrip dividend a lot. However, you have the option of receiving cash if you wish. Personally, I don’t like the scrip dividend as it dilutes the value of your shares by creating more shares for all investors. If you choose to let the company reinvest your shares with the scrip dividend, you acquire new shares without paying taxes. If you choose to receive cash, the bank / broker will automatically take personal income tax from you.
Why Do Only Some Companies Pay Dividends?
Many mature companies (Bluechip stocks) with stable earnings that do not need to reinvest as much in themselves issue dividends. Many investors like the steady income associated with dividends, so they are more likely to buy shares in that company. Investors also see a dividend payment as a sign of a company’s strength and a sign that management has positive expectations for future earnings, again making the stock more attractive. A higher demand for a company’s stock will increase its price. Some companies that pay dividends include Apple (AAPL), Microsoft (MSFT), Telefónica (TEF), Repsol (REP) and Iberdrola (IBE).
Rapidly expanding companies generally will not make dividend payments because during critical stages of growth they choose to reinvest the profit in operations. But even established companies reinvest their portions of their profits to fund new ventures, acquire other companies, or pay off debts. All of these activities tend to increase the price of the shares. Google / Alphabet (GOOG), for example, still does not pay dividends as does Warren Buffet’s company, Berkshire Hathaway, which is overflowing with capital to invest (and owns more than 60 companies). When an investor buys a share that invests his earnings and grows, the investor increases his equity without paying taxes until he decides to sell that share. However, you cannot receive income from your portfolio until you sell.
How Do You Choose Stocks That Pay Dividends?
Now that we know what and how it works, let’s see how to invest. We want to make sure we buy good companies with lasting dividends. First we review all the important criteria and at the end we look at the most key points to choose a good company without being overwhelmed with so many calculations and stories. You can find common figures and calculations by searching for each company / share on Google Finance (Yahoo! and more) or on your own broker’s page.
How to Do a Fundamental Analysis When Buying a Stock
The first thing we are going to look at is the fundamental analysis that is done when buying any stock, whether it pays dividends or not.
Income: This is the amount of money a company earned during the specified period. Sometimes the income is divided into “operating income” and “non-operating income.” Operating income is more revealing because it is generated from the company’s core business. Non-operating income often comes from one-time business activities, such as the sale of an asset.
Net income: This “bottom line” figure, so named because it appears at the bottom of the income statement, is the total amount of money a company has made after operating expenses, taxes, and depreciation are subtracted from income. . Income is the equivalent of your gross salary, and net income is comparable to what is left after you have paid taxes and living expenses.
Earnings and Earnings Per Share (EPS-Earnings Per Share): When you divide the earnings by the number of available shares, you get earnings per share. This number shows the profitability of a company per share, making it easy to compare with other companies. When you see earnings per share followed by “(ttm)” which refers to the “final twelve months”. Earnings are far from being a perfect financial measure because they don’t tell you how, or how efficiently, the company uses your capital. Some companies take those profits and reinvest them in the business. Others pay them to shareholders in the form of dividends.
Price / Earnings Ratio (P / E): Divide the current price of a company’s shares by its earnings per share, usually in the last 12 months, to get the final P / E ratio of a company. Dividing the stock price by the Wall Street analysts’ forecast earnings gives you the leading P / E. This measure of the value of a share tells you how much investors are willing to pay to receive $ 1 of the company’s current earnings. Keep in mind that the P / E ratio is derived from the potentially flawed earnings per share calculation, and analyst estimates are notoriously focused on the short term. Therefore, it is not a reliable independent metric.
Return on equity (ROE) and return on assets (ROA – Return on assets): The return on equity reveals, in percentage terms, how much profit a company generates with every dollar that shareholders have invested. The equity is the equity of the shareholders. Return on Assets shows what percentage of its profits the company generates with each dollar of its assets. Each is derived by dividing a company’s annual net income by one of those measures. These percentages also tell you something about how efficient the company is at generating profit. Here again, watch out for traps. A company can artificially increase return on equity by repurchasing shares to lower the denominator of equity. Similarly, taking on more debt, for example loans to increase inventory or finance properties, increases the amount of assets used to calculate return on assets.
The Dividend Yield
The first thing you usually look at when dealing with dividends (but not the most important thing) is the dividend yield. This is generated by taking the most recent dividend payment and multiplying it by the dividend frequency (how many times a year the dividend is paid) and then dividing it by the current share price.
Don’t look for high-paying dividends. The higher the return, the better for most income investors, but only up to a point. Abnormally high returns may indicate high levels of risk.
If you want to invest well in dividends, you can’t just choose the stocks with the highest dividends. There is often a reason why high dividend stocks pay so much. There could be problems with the underlying business, or the dividend payment ratio is too high and threatens future growth. The company may have a debt / equity ratio that makes investors believe that the company cannot survive in the long term. A good benchmark for investors is to compare a stock‘s performance to that of the S&P 500 Index (or one in your country) to get an idea of whether it is high or low, as market conditions can change over time. . Returns should also be compared to companies in the same industry as some industries tend to deliver higher returns than others.
Dividend Payout Ratio
Another metric that investors focus on is the payout ratio. The dividend payout ratio can be calculated as the annual dividend per share divided by earnings per share, or equivalently, dividends divided by net income.
Dividend Payout Ratio = Net Income / Dividends Paid
The dividend payout ratio is the proportion of earnings paid as dividends to shareholders, generally expressed as a percentage. Some companies pay all of their profits to shareholders, while others only pay a portion of their profits. If a company pays part of its profits as dividends, the business retains the remaining part. To measure the level of retained earnings, the retention ratio is calculated. Several considerations go into the interpretation of the dividend payment relationship, the most important being the level of maturity of the company. A growth-oriented startup that aims to expand, develop new products, and move into new markets would be expected to reinvest most or all of its profits and could be forgiven for having a low or even zero pay rate.
To learn more about solid financial investments for retirees please visit our “Money and Finance” category to learn more ways to retire with peace of mind, and as always thank you for reading with us here at Senior Resource Hub, we hope you found this information helpful!