Mannequin at the Weed Shop and Dividend Strategies
Is that a mannequin in the window?
Proper Cannabis opened a location close to my house, and I drive by it most days. Recently, I was surprised to see a mannequin in the window displaying a Proper Cannabis pullover sweatshirt and drawstring pants. The clothes looked nice, but I wouldn’t expect a cannabis shop to sell merchandise
It’s similar to dividends and investing. When they invest in stocks, many investors only consider gains and losses. Dividend payments are another way to profit from stock investing, and investors need to understand dividends.
This post defines dividends, explains the financial benefits of dividends, and reviews a strategy for investing in dividend-paying stocks.
Dividends: Facts and myths
A cash dividend is a share of the company's earnings paid to shareholders. The Board of Directors decides if and when a dividend is paid. Here are some dividend myths that I explain in my personal finance book:
Corporations must pay a dividend when they generate earnings:
Myth- there is no obligation to pay a common stock dividend when the business generates earnings. Many profitable companies, particularly high-growth companies, retain all earnings to fund the business.
Example: Microsoft went public in March of 1986 and didn’t pay a dividend until 2003.
If you have a net loss, you can pay a dividend:
Myth- you must generate earnings to pay a dividend. If you make payments to shareholders after generating a loss, the payments are a return of capital, not dividends.
Dividends must be paid in cash:
Myth- companies can also issue stock dividends.
Assume that Premier Company pays a 10% stock dividend, and that investor Sally owns 100 shares. Sally receives (100 shares X 10%), or 10 more shares.
That’s 10 more shares that can increase in price, earn a dividend — or both.
Only common stock shares can earn a dividend:
Myth- preferred shareholders can also earn dividends.
The word “preferred” means “better”, and that’s true of preferred stock. Preferred stock is better than common stock for several reasons, and one point relates to dividends.
If the company pays a dividend out of earnings, preferred shareholders receive their dividends before common shareholders. If there’s not enough money to pay the common stock dividend, only the preferred stock dividend is paid.
How valuable is the dividend?
OK, you receive a cash dividend. How valuable is it compared to other investments?
You can measure the value of a dividend using dividend yield and dividend payout ratio.
Dividends yield
Dividend yield reports the rate of return on a dividend, based on the current market price of the stock:
Dividend yield = (Annual dividend per share) / (Market price of common stock per share)
Assume Premier Manufacturing pays a $1.25 dividend when the stock price is $60 per share. The dividend yield is ($1.25 annual dividend) / ($60 market price), or 2.1% (with rounding).
Think about it this way: If an investor purchases Premier at $60 per share, they are “buying” a 2.1% dividend return.
Dividend payout ratio
The dividend payout ratio points out the percentage of company earnings paid as a dividend:
Dividend payout ratio = (Common stock dividend) / (Earnings available to common shareholder)
If Premier’s earnings per share (EPS) is $2.50, the dividend payout ratio is ($1.25 dividend) / ($2.50 EPS), of 50%.
A high dividend yield is more attractive, and a large dividend payout ratio means that the company is paying a bigger percentage of earnings as a dividend.
Dividend stocks as an investment strategy
Ned Davis Research has been a prominent stock research business for years, and a recent Wall Street Journal article quotes the Ned Davis viewpoint toward dividend-paying stocks.
“… dividend growers (firms that increase dividend payments over time) have done well, but that a more profitable strategy—albeit one that comes with greater volatility and turnover—is to simply focus on dividend yield.”
In other words, stocks with higher dividend yields may perform better over time, compared with the broad stock market.
Another point: You need consistent earnings to pay a dividend. If you pay a large percentage of earnings as a dividend, you need fewer earnings to grow the business. Profitable companies with larger cash positions and less debt don’t need to retain a large percentage of earnings.
They are financially healthy enough to operate without keeping the majority of earnings for business operations.
Maybe those stocks perform better? Food for thought. Consult with a financial advisor and get the facts.
My 5th book: “34 Stories That Explain Personal Finance”, is available here.
