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What You Need To Know About Dividends

What Are Dividends?

You may have heard the term dividends on the business news, or had conversations with people discussing their dividend income before.  Investors like to bring up what yield they can get on dividends, dividend stocks, dividend income in retirement, and much more.  What are these dividends, and how does it all work?

A dividend is simply, the earnings from a business that are eligible to be paid out to the shareholders (owners) of the company.  In plain english, it's the profits a company produces that isn't needed to keep the business running, so it can be distributed to the owners! There's many theories and strategies when it comes to investing for dividend income.  Before we can dive into those approaches, first let's consider how dividends are paid to you the shareholder. 

Jeff Bezos in pile of money

The board of directors at these companies will make a decision based on all the places they can allocate these profits.  They can pay down debt, invest in another business or products, spend more on marketing to grow, or simply pay out the leftover profits to the owners.  As a shareholder in a stock that pays dividends, you're entitled to these payments.  They are usually distributed quarterly.  

As I stated before, the board will determine each year how much or if they should pay dividends at all to the shareholders.  This number will always fluctuate as things change within the business, and based on opportunities the company sees to grow.  Many firms will not pay dividends at all.  They will take every single dollar of profit and reinvest it into the company to continue to grow and take market share as quickly as possible.  They may use the money to buy a competitor, pay down a high interest debt to become more stable, pay some engineers to develop a new product, crank up advertising to get more sales, and more.

This is the thought process that happens behind the scenes by management of these large publicly traded companies we invest in.  As a shareholder, you can decide if it's of value to focus on stocks that pay regular dividends each quarter, invest in stocks that may have volatile dividend payouts, or companies that don't pay out dividends at all and focus on growth.  Each of these should be considered before buying into a company long term.Dividends can be a great source of income in retirement for clients.  In addition to social security, and interest, if you have a portfolio of higher paying dividend stocks, you can expect to receive a nice paycheck each quarter, (while this is not guaranteed).  These companies tend to be larger more established businesses that aren't able to grow as much as the smaller up and coming businesses.  In this scenario, they find the best use of the profits is just to continue to pay out to you the shareholders.

Companies that don't pay out dividends, will use all the cash as gasoline on the fire to grow as quickly as possible.  These types of investments won't be expected to pay out consistent income for shareholders, but can potentially turn into the 100%, 200%, 5,000% gainers over time!  If there is a ton of expansion possible for a strong company with great management, reinvesting all those profits can lead to a massive increase in the overall earnings the company brings in.  This ultimately increases the stock price investors will pay.

There's many different considerations when it comes to investing in stocks.  Dividends should certainly be one of those considerations.  It's always based on the goal of your investments as well as an understanding on the company you're investing in.  Not everyone needs dividends, but for others it may be a necessity.  Regardless of your income needs, being a shareholder in great companies is almost always an excellent decision.

***Investing requires risk and loss of capital, this is not a solicitation of securities and purely for educational purposes." 

"If you can't use dividends, it's not a bad thing to give it to your shareholders.  They'll use it somewhere else."

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