Good morning & happy Monday!
Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.
John D. Rockefeller
I get feedback from many of you about these Monday morning memos (which I always greatly appreciate!). Some of you love the stories, some of you enjoy the examples, and some of you like the more technical emails. I will warn you that today is a little more of a technical email (I just lost a big portion of my audience 😉)
Today I would like to spend a few minutes discussing dividends.
What are dividends and how do they work?
When companies make a profit, they can do one of two things with those profits. They can either put the money back into the company for future growth or they can pay the profits out to their owners. When the company pays out profits to its owners that is called a dividend. If you own stock in a company, you are an owner.
Let’s say I am a 50% owner of a business that, after all expenses are paid, makes a profit of $1,000,000. Let’s say the company decides to take $500,000 of those profits and put them back into the business to open an additional location and takes the other $500,000 of the profits and pays them out to the owners. Well, if I am a 50% owner of the company then my dividend would be $250,000 (50% of the $500,000 in total dividends paid out). The belief is that the value of the business would increase with the investment of the additional location and that I would eventually profit from that as well.
As an equity (stock) investor I want 2 things:
- for the value of my investments to increase and
- to receive dividends from my investments
Value stocks (well established companies with solid track records of profitability) oftentimes will pay dividends. For this email I am going to use Coca-Cola as an ongoing example as that is a very well-known dividend paying company (please understand this is simply an example and not a recommendation). Coca-Cola’s current dividend is 1.76. More on that momentarily.
Growth stocks (companies in growth mode whose primary focus is increasing the value of the company) oftentimes will not pay dividends. Amazon or Tesla are examples of companies that don’t pay dividends because they would rather put profits back into the company for future growth (with the belief that will increase the stock price). There are plenty of good companies that do not pay dividends
Back to the Coca-Cola dividend example. What does a dividend of 1.76 mean? That means that the annual dividend paid by Coca-Cola to its shareholders (those who own their stock) is $1.76 per year. The dividend is paid out quarterly, so every quarter Coca-Cola pays out 44¢ for every share a shareholder owns. If I own 100 shares of Coca-Cola stock I would receive a dividend check for $44 per quarter (44¢ x 100 shares).
For most of our clients we reinvest dividends. In this example we would take the $44 we received in dividends and use those funds to purchase more shares of Coca-Cola stock.
Let’s take this just a bit deeper (in case I have not caused your head to hurt yet 😉). If Coca-Cola’s stock price goes down what happens to the dividend?
Nothing. The dividend yield is set by the board of directors of the company. For the first 2 quarters of 2022 Coca-Cola’s dividend was set at 44¢ per share. The 4 quarters in 2021 the dividend was set at 42¢ per share. It was 41¢ per share per quarter in 2020. (Dividends :: The Coca-Cola Company (KO))
Last thing on this this topic for today: Dividend yield.
Dividend yield refers to what percentage of the stock price the dividend reflects. So, for example, if a stock is paying $2/year in dividends (50¢ per quarter) and the stock’s value is $100 per share the dividend yield would be 2% ($2 dividend / $100 stock price)
Revisiting the Coca-Cola stock example, since the beginning of the year Coca-Cola stock has roughly been trading between $59-$66 per share. ( The Coca-Cola Company (KO) Stock Price, News, Quote & History – Yahoo Finance) If I were to buy Coca-Cola stock at $65 per share my dividend yield would be roughly 2.70% (1.76 annual dividend / $65 share price = 0.0270 = 2.70% dividend yield).
If Coca-Cola stock were to increase to $75 a share what would happen to my dividend? Nothing, it would stay at $1.76 annually (44¢ quarterly).
But, what would happen to my dividend yield? It would actually decrease to roughly 2.35% (1.76 annual dividend / $75 share price = 0.0235 = 2.35% dividend yield). Alternatively, if Coca-Cola stock were to decrease to $55/share my dividend yield would increase to roughly 3.20% (1.76 annual dividend / $55 share price = 0.0320 = 3.20% dividend yield). So, a decrease in stock price actually results in an increase in dividend yield (and vice versa).
Ok, ok, ok … I know that’s enough 😊 This is exciting stuff for me 😊
Please understand that we dive deep into dividends as one of many components when we evaluate investment strategies and build portfolios.
If you have any questions on this, or any, topic, please never hesitate to reach out.
Enjoy your week ahead!