How to Make Money on Dividends

Contents

By investing funds in securities, investors aim not only to preserve their savings but also to multiply them. In the case of stocks, there are two ways to earn money: by making a profit due to fluctuations in the asset price or by receiving dividends. The first option is rather simple: you buy the assets at a cheap price and sell them at a premium. If you opt for the second option, you should consider some important details. The topic of today’s article is how to make money on dividends.

How to Buy Shares in order to Receive Dividends

By purchasing shares of the company, the investor becomes one of its co-owners. They receive a share proportional to the number of securities they have purchased. Like any other business owner, they have the right to receive income based on how much profit the company makes.

Dividends are part of the company's net profit, which is distributed among the shareholders in proportion to the number of shares they own. However, not every company regularly pays dividends to investors.

Also note to improve their reputation and attract investors, some companies even pay dividends during periods of losses. For this purpose, they can use the retained earnings of previous years or borrowed funds.

The amount of dividends paid out depends on:

  • the company's dividend policy
  • decisions taken by the Board of Directors
  • the voting results at the general meeting of shareholders

The dividend policy determines how the profit is distributed among investors and what methods are used for this. Anyone can find this out on the relevant company’s website in the Shareholders section. Information about the frequency of payouts will also be included there.

The Board of Directors decides whether and how many dividends will be paid during a specific period of time. If the directors decide to spend all their profits on the development of the company, investors will be left without any income.

If the Board of Directors decides to pay out a dividend, it will discuss the matter at a general meeting of shareholders. Investors can expect to receive an income from dividends only if payouts are approved by a vote.

Advantages and Disadvantages, How Much Profit Can Be Made

The dividend strategy provides the investor with the following advantages and opportunities:

  1. They can earn passive income with the opportunity to generate a stable cash flow by buying the shares of several companies with different dividend payout periods.

  2. They obtain a long-term source of income by investing in the securities of financially stable companies.

  3. They can generate income in times of crisis. In a period of decline, the stock prices of companies that pay dividends are less susceptible to negative market influences. Sometimes their price might even increase during a crisis. But this is not typical.

  4. Payouts might increase in the future. As a company grows, the directors may decide to increase the amount of dividends paid out. Many organizations regularly increase payouts to investors. Some dividend aristocrats and kings periodically increase the amount of their shareholder income for 10, 25 and sometimes even 50 years in a row.

  5. Their profit can increase due to the reinvestment of financial proceeds. By reinvesting the income earned from dividends in new investments, investors can further increase their capital and cash flow.

  6. The risk of losses over a given period is minimal. The worst thing that can happen is that the company might not pay dividends. But we should also not forget that a company could go bankrupt.

Disadvantages of the dividend strategy:

  1. A company might not make enough profit to regularly pay out dividends. As a result, the investor's income will become unstable.

  2. The investor's capital can be reduced. If the issuer cancels the dividend payouts, the share prices can drop. The amount of funds available to reinvest will also decrease.

  3. The capital might grow too slowly. Companies that distribute all profits among investors have a slower growth rate than those that direct certain funds to their development. As a rule, even 1% of the additional yield of a stock can significantly affect the growth of the company's capital.

The amount of the investor's profit depends on the interest rate. You can make money on dividends only if their yield is high enough. This is the average dividend yield:

  • Globally - 3.23%
  • USA - 1.83 %
  • Japan - 1.89%
  • Korea - 2.14%
  • China - 2.28%
  • Brazil - 2.8%
  • Germany - 2.98%
  • France - 3.06%
  • Taiwan - 3.80%
  • Italy - 4.09%
  • Spain - 4.15%
  • Australia - 4.43%
  • Russia - 6.23%

Important Indicators for Profiting from Dividends

To assess the prospects of investments, the following indicators are used:

  1. Earnings per share (EPS). Companies publish this indicator in their quarterly financial statements. It reflects the portion of a company’s profit that is allocated to every individual share of stock. An increase in the EPS figure proves the efficiency of the business. But a consistent improvement in the EPS amount may also happen after a company reduces its expenses or sells its assets.

  2. Revenue. This indicator indicates whether a company organizes its business correctly. Growth in revenue proves that a corporation is developing. However, there may be no profit left if a company reinvests its earnings in new markets, technologies, lines of work, etc.

  3. The ratio of the cost of the asset to the profit for the reporting period to the expected profit (PEG). It is calculated as (P/E) / G. P/E is the ratio of the share price to the profit received and G is the indicator of the projected annual profit. Ideally, the PEG should be less than 1. If it equals 2 or more, the asset appears to be overvalued.

  4. The ratio of the company's borrowed and own funds. This indicator characterizes the degree of financial stability of the issuer. Dependence on creditors makes the company vulnerable, as loan terms may be tightened at any time and the organization may be declared insolvent or bankrupt. Ideally, the value of this indicator should be 0.1. If it is higher than 0.5, there may be problems in the future.

  5. The forecast of the joint-stock company management. The share price will often affect this indicator more significantly than any actual changes in earnings and revenue.

  6. Analysts' forecasts. Even though such forecasts are imperfect, they help people to invest in reliable companies.

  7. The dividend yield. This is the ratio of annual dividends per share to its value, expressed as a percentage. A high value of this indicator reveals the presence of possible risks. For example, in the US, a yield of more than 5% is considered high-risk.

When You Should buy Stocks in order to Receive Dividends

There are 3 options for purchasing shares:

  1. Before the company publishes its annual financial statements and the decision of the Board of Directors on the dividend payout. At this time, the price of the shares has not yet had time to grow and you can profit by buying them cheaply. But there is a risk that the issuer might fail to make a profit that year and therefore investors will not receive any income. Plus, the Board of Directors might decide not to pay the dividends at all.

  2. One day before the ex-dividend date. You will have to pay more for the share, but in this case, the dividend payout is guaranteed. The price will be higher for two reasons. First, the price of a stock often increases in the days leading up to its ex-dividend date. Secondly, the share price will fall by approximately the amount of the dividend payments on the following day. This is called the dividend gap. So the share price will be slightly cheaper on the ex-dividend date than on the day before.

  3. On the ex-dividend date or after it. You will be able to buy shares at a low price, but you will need to wait until the next payout season for dividends.

The Strategy for Buying Shares of Dividends Every Month

Let us now move on to how to make money from dividends. Even experienced investors sometimes fail to detect the optimal moment to purchase shares. To avoid waiting for this moment to arrive, you should use the “averaging” strategy. This strategy consists of buying shares regularly – every month, for example. It is important not to pay attention to price fluctuations at this point. If you buy shares at a lower price now and at a higher price later on, this will produce the effect of “averaging” the value of assets.

Which Shares to Buy to Get the Most Income

The least risky assets are known as “blue chips”. These are securities of the most reliable companies. But they do not always bring a good profit because the higher the risk, the higher the return on investment.

Therefore, the best option for obtaining maximum dividends is considered to be the shares of blue chips. They are characterized by increased risk but offer good return rates. When choosing a stock, you should pay attention to its liquidity, volatility and the issuer's reputation. The company should be growing and making a stable profit.

To form the portfolio, you should buy shares of several issuers. A combination of high-yield securities and reliable blue chips will help to increase the efficiency of investments while reducing risks.

To ensure a stable monthly income, you should purchase shares of companies that pay dividends every 30 days. Please note that there are only a few companies with monthly dividends. Alternatively, you can invest in the assets of several issuers with different payout terms, such as every quarter (there are many companies with quarterly dividends). In this case, you should distribute the companies in such a way that the dividend payout occurs alternately every month.

Earnings on dividends are associated with certain risks that you must take into account when forming an investment portfolio. Before buying shares, you should evaluate their profitability and the financial stability of the company. Investing in securities of several issuers will help you to reduce risks and plan a schedule for generating income. The amount of money that you can earn on dividends depends on your initial investment and systematic reinvestment.