Profit from Dividend Paying Stocks

Many companies are willing and able to pay their shareholders dividends. These represent money that is in excess of its earnings. They distribute this money in the form of dividends that are expressed in a per share amount. This means that the number of shares will determine how much you will get.

On the other hand, when you make a decision on in which company you should put your money, you should use dividend yield (also known as yield). It greatly facilitates the comparison between different companies. It is calculated by dividing dividend by the price of the stock. When you get that number you will know what percentage of the price for which you have purchased the stock will be retuned to you in the form of a dividend.

Unfortunately, companies are not required to pay dividends. For example, a growing company will need additional finances for its expansion. Thus it may decide not to distribute dividends. However, if a company doesn't pay dividends it doesn't mean that it is sustaining losses. The most well known example is Microsoft, which doesn't distribute dividends, but still its shareholders are satisfied with the company's results.

However, dividends represent a factor that will influence investors' decision if they are looking for a steady stream of income or are nearing their retirement years. Aside from the income it provides, dividends offer a relative degree of security. No matter what the movement in the price of the stock is, a company that pays dividends will continue to pay them.

Beware the High Dividend Yield Trap

You should not select stocks just because they have high dividend yield, because the latter can be influenced in a tricky way. For example, the price of the stock may drop significantly if it is not able to meet the earnings estimates. However, its dividend yield will be still high. As you can see if company was not able to meet the earnings projections, then some major problems may be in place. Thus, you should not consider the dividend yield as the only factor that influences your investment decision. You should make a closer examination of the business fundamentals of the company.

The payout ratio of the company is the data to which you should refer when you look for stocks with high dividend yield. The payout ratio presents information on the amounts of money the management of the company tends to distribute among shareholders in the form of dividends. Too much is not for good. It may mean that the company fails to reinvest enough money to sustain its activities.  Additionally, if the payout ratio is too high, then it can be interpreted as an indicator that the earnings of the company are not stable.

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