What are dividends and why are so many investors interested in dividends and dividend investing? This article will explain and introduce you to the general definitions of dividends and dividend investing.
1. Equity, Share and Share Holder
We will start the story with a group of 5 friends A, B, C, D, E. All 5 of these people have a business mind, after discussion, they decided to pool their money to establish a company.
Suppose the financial capacity of the 5 people is different, so the capital contribution will also be different. At this time, Mr. A will contribute 100 million, Mr. B, C, D will each contribute 200 million as usual, Mr. E has a slightly better financial condition, so he contributes 300 million.
The total capital of the company is now 1 billion, and based on the capital contribution ratio of individuals, Mr. A will get 10%, Mr. B, C, D each get 20% and Mr. E will get 30%. These numbers will lead us to the first concept, which is the ownership ratio (Equity) .
Figure: describes the concept of equity
To ensure fairness in ownership ratio, the company will be divided into many parts. For example, if divided into 10 parts, Mr. A owns 1 part, Mr. B, C, D own 2 parts each, and Mr. E owns 3 parts. And if divided into 100 parts, Mr. A’s ownership ratio will be 10%, Mr. B, C, D own 20% each, and Mr. E owns 30%.
The “part” that Mr. A, B, C, D, E owns will be called their shares in the company. And people like Mr. A, B, C, D, E, who hold shares of the company will be called shareholders (Share Holder) .
2. What is dividend?
When a company develops and makes a profit, of course the company will share that profit with the shareholders (Share Holders) who own shares (Shares) of the company, and that profit is called dividend .
Figure: Describing the concept of dividend in an easy to understand way
In short, a dividend is the portion of a company’s profits, after deducting the amount reinvested, distributed to shareholders. The dividend schedule varies from company to company, and can be quarterly, semi-annually, or annually.
3. Dividend Investing Strategy
Investors in this form will focus on companies that pay high and stable dividends, from which the profits from these dividends will be a source of passive income for them. This strategy is similar to spending money to buy a house and renting it out, and every month the rent will be sent to you as a form of passive income.
That is why people also call this strategy income investing .
And there are usually two main forms of dividend payment to shareholders, which are cash dividends or stock dividends. Investors will tend to choose to receive stock dividends instead of cash, to increase the number of shares they hold, thereby increasing the value of the investment they have spent.
However, it should be noted that companies have the right to stop paying dividends if they want. For example, if the business situation is not as expected so they do not make a profit, or they need capital to invest in a new field, they have the right to stop paying dividends or reduce the dividend payment rate.
In fact, there are stocks of companies that are specifically designed to attract this type of investor, and these companies attract investors with their dividend policy rather than with the company’s growth potential.
Since the most attractive factor of these companies is dividends, they will try to avoid not paying dividends or reducing the dividend rate as much as possible. If they do so, investors will sell the company’s shares and move to other companies, and as we know, if too many people sell, the company’s value will go down.
“When a company starts paying dividends, it no longer knows what to invest in” – Elon Musk
Some advantages of this strategy:
- Create passive income .
- Usually these dividends will come regularly and in most cases we can predict in advance, which will help us plan our expenses in life more easily (periodic and stable income).
- If we spread out and invest in many companies, even if the dividends of some companies increase or decrease or some companies stop paying dividends, we still don’t have to worry because this income changes too much (mental comfort).
- These investments will be less affected by inflation.
In addition, this strategy also has some disadvantages as follows:
- Because it generates more income for you, you have to pay more taxes, and usually companies will automatically deduct this tax before paying dividends to you, meaning the dividends you receive are tax-inclusive.
- Companies in this investment strategy will often grow very slowly, but in return, this investment will be safer. And if companies spend too much money on dividends, they will not have much capital left to reinvest or invest in other areas. Therefore, shareholders tend to want to receive more dividends to create conditions for the company to have enough cash to grow.
- In my personal opinion, this form of investment is quite boring because we don’t have to do anything, just throw money in and wait for dividends.
- However, because the dividend payout ratio is also relatively small, you need to have a certain amount of capital to be able to clearly see the growth of this investment.
In general, this is a relatively safe strategy and is suitable for those who do not like to look too much at the electronic board and do not want to pay too much attention to the market. To ensure that you can receive high and stable dividends, my advice is that you should choose Blue chip companies , which are large companies, have developed steadily and are unlikely to go bankrupt in the near future.
With such Blue chip companies, although it will be difficult for them to have a breakthrough in growth and the cost of buying shares will be quite large (because their stock value has also increased quite high with the company’s development), in return, their annual profits will be relatively stable, so the dividend schedule will also be more stable.
As for small, unstable companies, the dividend rate will be higher, the purchase cost may be cheaper but there is no stability, and because this is a long-term investment strategy, these small companies will have higher risks than Blue chip companies.
A Blue Chip company is understood to be a company with a nationwide reputation. Currently, a Blue Chip company will usually be established for a long time and have a healthy financial source. Blue chips will usually sell high quality products and services that are widely accepted . – luatduonggia.vn
4. Classic Case Study of Dividend Investment Strategy
Ronald Read (October 23, 1921, USA) was a gas station attendant and security guard at a JC Penney supermarket.
In 2014, Ronald Read passed away at the age of 92. Afterwards, his family and those around him were shocked to learn that this man had somehow miraculously acquired $8 million (more than VND192 billion).
After research and study, it was discovered that his million-dollar fortune came from his stock investment and the only strategy he used was dividend investing. This is a strategy that investing legend Warren Buffett loves and often recommends.
He buys and holds Blue Chip stocks. These are stocks that provide stable income, are low risk, and do not pay high dividends. They are usually from companies with large market capitalization.
Read picked good stocks and held them for the long term. He also avoided investing in stocks he didn’t understand, like tech companies. Over time, Read’s investments grew and eventually reached $8 million.
The Wall Street Journal reported that Read owned more than 95 stocks at the time of his death in 2014, many of which he had held for years, if not decades. Read’s longtime holdings included Procter & Gamble, JP Morgan Chase, General Electric, Johnson & Johnson.
Lessons learned from Ronald Read’s case study:
- Reinvesting dividends: Read remained very frugal despite the fact that he could have lived his final years in more comfort and luxury. He reinvested his dividends and this helped his fortune surpass what most people think a supermarket security guard could earn.
- No speculation: Read only buys Blue Chip stocks and does not invest in “hot” stocks like technology or digital currencies. Legendary investor Warren Buffett once said: “If you are not willing to hold a stock for 10 years, do not even think about holding it for 10 minutes.”
Photo: Mr. Ronald Read, one of the very successful people with this form of dividend investment.
Thank you for reading my sharing, hopefully it has brought more or less useful value to you.
- Sky -