Understanding Dividend Stocks in 8 Questions

In collaboration with National Bank Direct Brokerage

At a time when growth stocks are falling out of favor, dividend stocks can win the day. Here are 8 questions to learn more about dividends.

1. What is a dividend?

A dividend is a share of a company’s profits distributed directly to eligible shareholders. In the stock market, capital gains and dividends are two ways for an investor to get a return on their investment. Basically, capital gains from rising stock prices are the fundamental compensation for investing in the stock market. 

For example, an investor owns 100 shares of Company XYZ at a price of $10 per share, for a total of $1,000. If the price of the shares rises by 5%, the investor sees his capital increase by $50. Another way to compensate the investor is through dividends: for the $1,000 he holds, the company can pay him a “dividend” of $0.50 per share, which gives him an income of $50. 

2. Why do companies pay dividends? 

Whether the stock price goes up or down is not under the direct control of the management. The dividend is. By paying a dividend, the company is directly rewarding the investor for his or her confidence in the company. But not all companies pay dividends. It’s important to determine your investment strategy and, as a result, choose wisely whether or not to buy dividend-paying stocks.

3. What is a dividend yield?

The dividend yield is simply the amount of the dividend declared by the company, divided by the price of the stock. 

4. What is the dividend payout ratio?

Another way to evaluate the dividend is through the dividend payout ratio. By dividing the annual dividend by the annual net earnings per share, the investor can get an idea of how much of the company’s earnings are being retained for the dividend. Beware: a high ratio may indicate that the company reinvests little in the business, which may weaken it in a more difficult business environment.

5. What is the difference between the payment date and the ex-dividend date?

The payment date is the date on which the company pays out its dividend to investors. The ex-dividend date is the date after which any new shareholder is not eligible to receive the dividend declared on the payment date. The day after the ex-dividend date is the record date, when the company checks its records to see if all shareholders of record are eligible to receive dividends. For example, if the payment date is May 1 and the ex-dividend date is April 28, all shareholders of record on or before April 29 (the record date) will receive their share of the declared dividend after a few weeks.  

6. How do you choose a good dividend stock?

The smart investor will look at more than just a dividend yield. A company’s stock, even if it pays a high dividend of, say, 8%, may be in free fall, indicating that the company’s situation is deteriorating. There are a few critical questions an investor should ask. For example, is the dividend yield stable and increasing over time? Are profits, and more specifically cash flows, growing? Note that growing cash flows indicate the possibility of higher future dividends. Is the balance sheet healthy and continuing to get healthier? How good is the management team?

7. To reinvest dividends or not?

Generally, a retiree will cash in his or her dividends as they come in. A younger investor who does not need regular income can reinvest the dividends they receive in the company’s stock. This way, without any special effort, they increase their capital investment and future dividend income potential. With a National Bank Direct Brokerage account, you can enroll in the dividend reinvestment program.

8. How do I find the right dividend stocks?

National Bank Direct Brokerage has sophisticated tools to separate the wheat from the chaff. Strategy Builder, for example, can help optimize a portfolio of dividend stocks. 

Dividends are another powerful way to make money by investing in the stock market. By dealing with a discount broker that offers all trades at $0 commission, your assets are directly invested in your investments. 

Arthur Dubois is a personal finance writer at Hardbacon. Since relocating to Canada, he has successfully built his credit score from scratch and begun investing in the stock market. In addition to his work at Hardbacon, Arthur has contributed to Metro newspaper and several other publications