Investing 101: Dividends explained - MoneySense

Investing 101: Dividends explained

These tiny payments can really transform your portfolio

M A K I N G   B A N K


Do you know what a dividend is? If you’re not already pretty entrenched in investing you may not have a clue—And that’s okay. These things weren’t part of the curriculum, were they? (Now, the Pythagorean theorem, on the other hand, is forever engraved into my brain and let me tell you, it’s not going to make me any money.)

So, let’s get into it.

What are dividends, and why should you care about them? Dividend stocks are stocks that you buy that pay you for being invested in them. Well, it’s not the stock that pays you, it’s the company whose stocks you’ve bought that’s giving you a little gift for being a shareholder.

That money—the dividend—is technically part of the company’s profit that’s being given back to the shareholders. Sometimes these payments are worth mere pennies per share. That may sound insignificant, but they can really add up.

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Consider this. Let’s say you own 1,000 shares trading at $10 per share. Now let’s assume that company pays a quarterly 1% dividend. On a per share basis, you’d get 10-cents, but on 1,000 shares your dividend would be worth $100 on those shares. Not bad deal for simply owning a stock.

That percentage figure is commonly referred to the dividend yield, which is simply a ratio that compares how much a company will pay out in dividends in a year, compared to that company’s share price. As you start to look around you’ll discover some stocks have high yields (say 5% or more) while others might be smaller. Before I go on, a word of caution: while high dividend yields are enticing they can also be a sign of a company in trouble—but more on that in a moment.

First, lets consider a real-life example. TD Bank, for instance, has a share price of $65.83 and a dividend yield of 3.68%, meaning over the course of the year you can expect to get $2.42 per share back in dividends. It might not sound impressive, but trust me it is. Since dividends are often paid out every quarter, you’d get 60.5-cents per share, per quarter. If you’d owned 100 TD shares then you’d get back $60.56 in dividends. At the end of the year you’d have collected about $242 in dividends.

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Remember, since the yield is based on the share price it will fluctuate over the course of a year, but barring some calamity, the amount you’ll collect in dividends should remain constant. Confused? Look at it this way. Let’s say TD’s shares shoots up to $100 per share. The dividend yield now would be 2.42%, and as you can probably guess the annual dividend would still be $2.42 per share.

Your entire portfolio shouldn’t be full of stocks, but it’s not a bad idea to make sure the ones you do own have good dividends so you’re making even more money. What’s more, those dividends can be reinvested, giving you new shares in the company, which allows you to collect even more dividends.

But before you go out on an investing adventure and buy every stock with a high dividend yield, watch out.

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A high dividend yield isn’t always a good thing. That’s important to remember. You really don’t want to get fooled by a 10% dividend yield. Don’t let double-digit numbers deceive you. A high yield percentage could just mean that the value of the stock has fallen, and that the company is going to soon cut the dividend. Now that you know the basics, here’s what you need to know about buying a quality dividend stock:

Be sure to check back for regular updates as Prajakta leads us on a journey as she learns what it takes to invest her own money.