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Definition:  Dividend investing is an investment approach of purchasing stocks that issue dividends in an effort to generate a steady stream of passive income. Companies distribute cash dividends to their shareholders periodically during their fiscal year, but most issue them on a quarterly basis.

What Does Dividend Investing Mean?

What is the definition of dividend investing?  Each quarter, on the  dividend declaration date , a firm’s board of directors declares the dividend amount that will be distributed to the firm’s shareholders. Only the  shareholders  who owned the stock on the  dividend record date , i.e. the date that the firm reviews its lists to determine the shareholders of record, receive a dividend.

Shareholders who do not own the stock on the dividend record date are not entitled to receive a  dividend . Likewise, investors who buy the stock on or after the ex-dividend date do not receive the firm’s dividend.

Usually, dividend investors are interested in a firm’s dividend payout ratio and dividend yield. A dividend payout ratio between 40% and 50% indicates that the firm distributes almost half of its retained earnings to its shareholders while the remaining is invested in the launch of a new product or to lower the short-term debt. The  dividend yield  may lead to a large cash income.

Let’s look at an example.

Example

A steel manufacturing firm has released its quarterly results and has a net income of $250 million. The board of directors decides to pay $120 million in cash dividend and reinvest $130 million in lowering its short-term debt. This means that the firm’s dividend payout ratio is dividend / net income = $120 million / $250 million = 48%.

The board of directors declares a quarterly dividend of $0.95 per share, reaching an annualized dividend of $3.8 per share. The stock currently trades at $88; therefore, the dividend yield of the stock is dividend / stock price = $3.8 / $88 = 4.32%. A shareholder that holds 10,000 shares will be compensated with 10,000 x 4.32% = $432.

On the ex-dividend date, the stock price declines to adjust to the dividend paid. Therefore, the firm’s stock that trades at $88, and pays a quarterly dividend of $0.95 per share, ceteris paribus, the stock will open at $88 – $0.97 = $87.03 on the ex-dividend date.

Summary Definition

Define Dividend Investing:  Dividend investing is an investor strategy of only buying stocks that issue dividends thus creating a reoccurring income stream.


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