Dividends are when corporations choose to hand out some of their earnings to their shareholders. Sometimes, this is paid out in cash. Other times, this is paid out in the form of more shares. For that matter, it should be mentioned that dividends can be paid out using other assets, though such occurrences are rather rare. Of course, dividends can differ from one another in a wide range of other ways as well. For example, some companies hand out dividends on a regular basis. In contrast, other companies hand out dividends on special occasions, whether because they have some extra cash on hand or because they have had some kind of unexpected windfall. Generally speaking, it is the established corporations that pay the most generous dividends as well as the most regular dividends. Meanwhile, their less established counterparts tend to reinvest their earnings in their operations for the purpose of fueling further growth. Something that is so ingrained in the public consciousness that corporations choosing to hand out their earnings rather than reinvest them has been known to cause shareholders to suspect them of having run out of growth opportunities.
Still, shareholders tend to like dividends because most people like being paid more money. As a result, dividends can have a fair amount of influence over a stock’s share price. Due to this, those who are interested in stocks would be well-advised to look into their dividend history because of the effect that dividends should have on their investment choices.
Anticipation Is a Powerful Factor
It is very common to see a stock’s share price increase when a dividend is announced. This happens because such an announcement increases the interest of shareholders in the relevant stock. Moreover, since they know that they can collect a dividend so long as they get their hands on the share before the ex-dividend date, they are willing to pay a premium. Combined, these effects drive up the share price in a classic display of rising demand. Once the dividend has been paid out, the share price tends to fall once more as investors return to their normal level of enthusiasm. Having said that, it should be mentioned that the market is far from being perfect because humans are humans. As a result, while the share price tends not to rise beyond the approximate value of the dividend, there are cases when the increase in the share price exceeds the approximate value of the dividend. Something that can be very lucrative for shareholders who have managed to pick up the right stocks at the right times. In fact, there are some investors who specifically seek to buy shares just before their dividends are paid out before selling them once their dividends have been paid out.
Consistent Dividends Make for Popular Stocks
Another excellent example would be how consistent dividends make for popular stocks. To an extent, this is because more money being paid out makes for happier shareholders. However, it should be mentioned that a lot of people interpret consistent dividends as a sign that the corporation is doing well, which is particularly true when those dividends keep on going up and up. Sometimes, this is true. Other times, well, suffice to say that corporations can pay out dividends even if they aren’t making a profit, though that will mean a worsening of their financial position. Similarly, just because a corporation isn’t paying dividends on a consistent basis, it doesn’t mean that they are doing poorly. As mentioned earlier, it is very common for corporations to reinvest their earnings in their operations, thus putting them in a better position from which to make even more money in the future. In any case, consistent dividends are also important because some investors are very drawn to such stocks. These investors want the growth potential of stocks while still enjoying a regular stream of cash from their investments, thus making stocks with consistent dividends over time very attractive to them. Of course, if a corporation with a history of paying out consistent dividends fails to live up to that history, the results can be very dramatic.
The Valuation of Stocks
There are various methods that interested individuals can use to estimate the value of stocks. Naturally, dividend history plays an important role in such calculations. For an excellent example, one of the most common methods to calculate the value of a stock is to add up the present value of all of the dividend payments that will happen in the future. Said method requires three pieces of information, which would be the most recent dividend amount, the growth rate for the dividends over the course of the stock’s dividend history, and the rate of return that the investors either requires or considers to be the minimal that they are willing to accept. After which, the present value can be calculated as the dividend amount divided by the difference from the required rate of return minus the dividend growth rate. Of course, the downside to this particular method is that it is too simplistic. As a result, even if interested individuals do everything that it demands of them, the result isn’t necessarily going to be a good estimate of the stock’s intrinsic value.
For further proof of the usefulness of a stock’s dividend history for evaluating its value, consider the ratios that incorporate such information. One, dividend yield can be calculated as the annual dividend paid for a share divided by the price of that same share. This isn’t very complicated, but this is nonetheless a useful way for interested individuals to compare the attractiveness of various stocks when it comes to dividends. Meanwhile, the dividend payout ratio is calculated as a corporation’s total dividends divided by that same corporation’s net income in the same period of time. It isn’t meant to gauge the attractiveness of stocks when it comes to dividends. Instead, it is meant to figure out whether the corporation can keep up dividend payments in the future. These as well as other ratios involving dividends can be used to gauge a stock’s value, which in turn, influences the price that people will pay for the relevant shares.