What are dividends and why you should buy them

What is a dividend?
A dividend is a portion of a company's earnings that can be returned to shareholders, they provide an added incentive to buy stock in stable companies even if they are not necessarily growing that much, there are many companies that pay a regular dividend to their stockholders. Dividends are used to pass their profits directly to their shareholders, it most often comes in the form of cash - a small percentage of profits to the owner of each share of stock but sometimes they are paid in the form of stocks.

They can be determined by a fixed rate known as preferred dividends, or a variable rate based on the latest profits known as common dividends. If a limited company has any money left after paying all business expenses and liabilities plus any outstanding taxes it can then distribute these funds in the form of dividends to its shareholders and from April 2016 you don't pay tax on the first £5000 of dividends that you get in the tax year.
Why dividends? 
They offer a consistent return on a relatively low-risk investment, you can buy into companies that have stable business and low growth and still know that the value of the initial investment is unlikely to drop a lot and they will get profit from the company's dividend payments. They can also benefit from the company growing which will mean the dividends can grow and provide even more profit.

Other ways to profit from dividends
Immediately after the dividend is announced some investors will purchase the stock, collect the dividend then attempt to sell it for the same price, in theory this would mean the investor has received the dividend for free however the stock price will typically adjust immediately to reflect the dividend payout, as investors will know that the stock no longer includes the current dividend payment.

Dates to consider
The declaration date is when the company sets the dividend payment date, the amount of the dividend and the ex-dividend date. The record date is where the company makes a list of all current shareholders who will all receive a dividend date. The most important date is the ex-dividend date which is typically 2 days before the record date, if an investor does not own the stock before the ex-dividend date, they will not be eligible for the payout.

What to look for in a dividend
Dividend safety - this is mostly measured by the dividend coverage ratio, basically how much of a profit cushion the company has compared to how much it is paying out in dividends. Either a high dividend yield or a high dividend growth, high yield gives high income now whereas the latter will in theory give as much or more however many years down the road. Ideally you want to buy a few dividend stocks that are at a good price with a good yield and then aim to control the risk on them, if you buy them near the lows of the long term price ranges, but hopefully not when it is heading for rock bottom.

If you're ready to dive into the world of dividends check out Google's Stock Screener or have a read through one of these books for less than £5: dividends 101dividend growth they are free with kindleunlimited, and you can also get The Ultimate Dividend Playbook for free via Audible.

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