If you are a relatively new investor, then welcome to the world of investing! One of the more common questions among new investors is “Should I invest in dividend stocks?”
Today I’d like to discuss several points on dividend investing in easy-to-digest terms.
Why investors like dividend shares
A dividend is a distribution from a business to its shareholders. Dividends, which are usually paid from after-tax profits, are determined at the discretion of a company’s management.
For many people, investing in a dividend-paying, blue-chip share is often one of the first steps to get started. Any capital gains delivered by the stock is an added bonus on top of the dividend.
When investors reinvest dividends, they put the payment back into buying more shares. Income investors know that they can compound their returns through reinvesting dividends. Many investors also rely on dividends to supplement their income or even to completely fund their lifestyle.
Investors should perform due diligence to ensure that a given share is suitable for their portfolios. The cash flow statement shows a company’s cash inflows and outflows during an accounting period and acts as an important point of reference.
Ultimately dividends are supported by a company’s free cash flow – cash from operations minus tax, interest expense, capital expenses (capex), and adjusted for working capital requirements.
Therefore when a company has positive or growing free cash flows, it could signal to investors that the company is financially robust enough to fund its future payout. Companies would be unable to sustain dividends without sufficient cash flow.
FTSE 100 shares
As one of the highest-yielding markets in the world, the FTSE 100 currently has a generous dividend yield of 4.5%. The FTSE 100 consists of the 100 UK-listed stocks with the biggest market capitalisations.
Most of the shares in the index declare regular dividends. Notable exceptions are Ocado Group and Just Eat.
In the UK, dividends on ordinary shares are normally paid twice a year. Ashtead, Bunzl, and BT Group are examples of business that pay first an interim and then a final dividend.
However, there are also several London-listed securities offering quarterly dividends, such as British American Tobacco, Lloyds Banking Group, and Unilever.
One of the reasons companies may decide to pay dividends quarterly is to send a signal to the market that they have strong balance sheets with positive cash flows throughout the year.
Several investment trusts also pay quarterly dividends. Two such trusts are the UK Commercial Property REIT and Schroder Real Estate Investment Trust.
If you are interested in dividend stocks, but not quite sure where to begin, a low-cost FTSE 100 tracker fund might also be appropriate.
Over the past two years, with uncertainties around Brexit and US-China trade wars, the FTSE 100 has been volatile and at times out of favour with many investors. As share prices have gone down, dividend yields have gone up.
Yet another factor that has helped increase UK dividend yields is the growth of special dividends.
If it has been an especially strong year in terms of revenue, a company’s board of directors may decide to share part of the profits with shareholders by declaring a special dividend.
In the past few years many companies, including Barratt Developments, BHP Group and Next, have been paying out special dividends to appeal to more income-seekers.
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tezcang has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.