What Exactly Are Dividends?
There are definately a lot of excellent dividend paying stocks that can give their shareholders the ability to earn a little extra money off of their investment. But what are they and why do companies pay them out?
Basically a dividend is a way for the company to share their earnings with their stock holders. If the company is profitable they may distribute a percentage of their earnings to their shareholders in the form of a dividend.
Dividends are spread out to each investor depending on how many shares of stock that investor holds. For example say the company distributes $400 million dollars to their stock holders and there are $800 million shares of stock, that means for every 1 share the investor holds they get $.50 in dividends. Not only does this keep the investors happy, but it also helps to get more investors to invest into the company.
It could also show that the company is strong because if they have extra money to pay out some dividends they must be doing something right. Normally a high dividend is a sign that the company is making a nice cash flow, but this is not always the case.
There may also be a problem with the company. Some companies are not very strong and are just paying out a dividend to get new investors to come in and save the company from failure.
So, if all you do is go out and get a list of dividend stocks and buy them all, then chances are you will get into a few of these terrible companies. No matter how strong the dividend is will become utterly worthless if the stock goes to $0 in the next 6 months.
By looking at many different fundamental factors and ratios such as the PE Ratio you can increase your chances of getting into companies whose stock will likely appreciate in the future and you are not relying totally on the dividends it is producing.
While dividends can be a fantastic way to get an added bonus on your investment, they are not the only reason to invest in the stock market.
