Everything is relative in the stock market. Prices and dollar amounts mean nothing until you have something to compare them to.
There are stocks that sell for pennies, and then, on the other end of the price spectrum, one of the most famous and best-performing stocks sells for tens of thousands of dollars per share (primarily because it’s never split over the years of its growth).
The same holds true with dividends, or the quarterly (sometimes semi-annually) payments companies make to their shareholders as a means of sharing net profits. Some are measure in pennies per share, others pay many dollars per share.
The Relative Nature of Dividends
Dividends are never guaranteed, they depend on profits because they are profits being shared among the owners of the company (the shareholders).
There are exceptions to this with return of capital dividends (which aren’t from profits) and preferred stocks (which are from profits, and are promised to this class of shareholder before common stock shareholders see a penny), which means investors who are picking stocks with a view toward a regular cash return through dividends need to be very aware of a company’s performance and prospects.
When someone refers to a company paying a high dividend, they’re talking about the percentage of the stock’s value, rather than the amount of money involved.
Running The Numbers
For example, if a company selling at $100 a share pays out $2 a year in dividends (2%), this is a relatively low dividend payout. Why? Because another company selling for $20 a share might also pay out the exact same amount, $2 a year in dividends (which is 10%), which in this case is a very high payout.
Why do some companies pay more than others? It depends largely on their industry niche, their need to attract new investment capital, and the competitive landscape with a given state of the economy. In the competition for investor dollars, dividends can be the tie breaker and the thing that draws new money to their capital investment strategies.
And, they are the primary price determinant for some stocks in the market in general. Raise the dividend, and the price in the market will go up to correspond with the going rate of return for companies at that level.
The Core Nature of Dividends
Of course, that overview assumes you know that when you invest in a company by buying shares on the stock market, the company itself doesn’t get a dime of your money – the person selling you the stock does. But, the company does pay dividends to whoever owns their shares, which means they can maintain their stock’s inherent value in the marketplace through a consistent and generous dividend payout strategy, rather than depending on price appreciation to do the job.
Electric utilities are known as dividend-driven stocks because the nature of price regulation and competitive limitations, both of which constrain the amount of profits and growth they can expect. If a company can’t grow, investors are hesitant to come on board. So they use dividends to attract new capital, paying out sufficient money per share to attract investors to their stock on a percentage return basis.
Investing for a Return
You can put your money in the bank at 2%, or you can invest in a company that traditionally pays out a 5% return to its investors through its dividends.
It’s not for everyone, because everyone can’t tolerate the risk factors of being a stockholder – though electric utilities, for the very same regulatory reasons, are traditionally less risky than other types of corporations.
So when you hear the term high dividends, make sure you look closely to see what that really means. And then do the math – it’s the return on investment that counts, not the number of dollars per share.
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