Some investors put their money in a company's stock because it pays good dividends.
But what is a stock dividend?
Dividends are what companies pay out to shareholders when the companies have attained a certain level of success, says Mr David Kuo, CEO of online investment publication The Motley Fool Singapore.
He adds: "Dividends can only be paid from current profits or profits that (the company) has made in the past."
So what are good dividends?
There are two ways to measure this.
The first way is through dividend yield.
This tells you what a company pays out to shareholders in the form of dividends in percentages.
In simple terms, dividend yield is the annual dividend per share divided by the stock's price per share.
So if a company's annual dividend is $1 and the stock trades at $10, the dividend yield is 1/10 = 10 per cent.
Good dividends hover around 4 per cent.
Blue chips tend to give out better dividends and are more consistent on this front.
The second way is by constantly growing dividends.
As the company grows, it allocates more of its earnings to dividends.
For example: Company A gave out 30 cents per share when its income was $10. The dividend payout ratio was 3 per cent.
But when its income grew to $20 and it still gave out 3 per cent, the dividend per share is now 3 per cent x $20 = $0.60 per share.
SGX market strategist Geoff Howie says a common perception is that a high dividend yield indicates that the dividend pays a higher return on the stock prices.
However, the actual scenario may not be so.
"An investor has to be careful when investing in stocks with abnormally high dividend yields as the high yields may be due to, first, declines in their share prices or second, a one-time special dividend," he says.
He adds that as a general guide, real estate investment trusts generally have consistently higher dividend yields than traditional stocks.
"Stocks which are consistently growing their dividends can be a clear indication that these companies are doing very well.
"Simply put, those increasing earnings are allowing the companies to pay higher dividends," he adds.
So how do you pick stocks based on dividend payouts?
Mr Howie has three tips:
- Look for companies with firm and clear dividend policies, whereby the organisation sets a clear dividend payout policy.
- Look back in history to see whether a particular stock has been growing its dividends consistently.
- Keep an eye out for companies which pay dividends regularly and are experiencing strong growth in their businesses.
Often, dividends are paid out to shareholders of a profitable company. How big a return you want to see is dependent on whether you are a long-term or short-term investor, says Mr Kuo.
Most investors go in for the long haul and those tend to steer away from the extremely high-yielding investments.
The rationale behind it is whatever pays well today may not pay the same tomorrow, adds Mr Kuo.
"It is important to check to ensure that the company has been able to grow its profits consistently, and that it could steadily increase its payout to shareholders.
"Generally, if something looks too good to be true, it probably is."
This article was first published on July 03, 2016.
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