Money Talks with Jonathan Perrin: Episode 2
Follow along and hear the latest on all things current in the financial sector with Jonathan Perrin, a current professional baseball player and also certified financial advisor. Here we hear from an expert on both sides of the field and give you insights to latest trends in the market from a professional athlete. Think A Frugal Athlete's version of Mad Money with Jim Kramer.
Companies that earn profits can use that money to do three things. 1) Reinvest those profits into the business for growth or to pay down existing debt. 2) Use the excess cash to buy back their shares to reduce the total number of shares outstanding. Or 3) Pay out a part of those profits to their shareholders in the form of a dividend. For younger less stable companies focused on growth, they will typically take most of those profits and choose the fist option to continue to grow the business. More established and financially stable companies that have more mature businesses will begin to take that profit and pay the shareholder directly to entice investment to make up for the lack of growth potential. In this edition of Money Talks we are going to focus on dividends, and how they can help you as investor.
Before we get started, here are a few basic terms associated with dividends that you will see often and will need to know.
Dividend Yield – The ratio in which a company pays out its dividend relative to a share price. If you are looking at a stock quote you will notice that dividend yields are shown as a percentage. The calculation for a dividend yield is: the annual dividend per share/price per share.
For example: as of market close on 5/18 Apple was trading for $186.31 per share and its most recent quarterly dividend payment was $0.73. You take the annual dividend ($0.73 x 4=$2.92) and divide that by the share price of $186.31. 2.92/186.31=0.0156. Which gives you a dividend yield of 1.57%.
Declaration Date – The day that a company announces the next dividend payment.
Ex-Dividend Date – The before the record date, if you purchase a stock on or after the ex-dividend date you will not receive the next dividend payment. If you purchase the stock before this date then you are eligible to receive the upcoming dividend.
Again, using Apple as an example their most recent dividend had an Ex-Dividend Date of 5/11/18. Any shareholders that owned the stock on the 10th or before would receive the dividend.
Record Date – The day a company determines its shareholders of record.
Payment Date – Date that the dividend is scheduled to be paid to shareholders. Apple paid the most recent dividend on 5/17/18
Special (One-Time) Dividend - A special dividend, also called a one-time or an extra dividend is a payment made outside of the regular dividend. These types of dividends are typically made during a time of exceptional profits for a company, or during a financial restructuring.
Dividends are payments made by a company to its shareholders in form of either cash (cash dividend) or stock (stock dividend). Typically, when you are a shareholder of a dividend paying stock you are given the opportunity of choosing between a cash payment of the dividend or reinvesting those dividends. When an investor chooses the dividend reinvestment option; you forgo the cash payment and instead you opt to receive a stock dividend instead. The investor is given an equivalent number of shares (which can be fractional) of stock to the cash dividend that you would be paid. This is typically done through what is called a DRIP-Dividend Reinvestment Plan.
Choosing whether or not to take the cash payment, or to reinvest and receive the stock dividend instead depends on your investment timeline and your current financial needs. For long-term investors reinvesting dividends and taking advantage of the compounding interest that occurs over time as the dividend payment grows larger as you accrue mores shares with each dividend reinvestment can be a very powerful way to grow your portfolio. Let’s look at an example of the power of compounding interest and reinvesting dividends: Say you purchase 100 shares of a stock for $100 per share, and this stock had a dividend yield of 3%. So, your initial value of this stock is going to be $10,000. Let’s say that you hold this stock for 20 years and the share price and the dividend yield stay exactly the same for the entire time (this would surely never happen in real life, but for the example it makes it easy). So, the dividend of the 3% would pay you $300 per year every year resulting in a total of $6,000 in cash payments over the course of 20 years. Making the total value of your investment $16,000 (100 shares still valued at $100 + the $6,000 in cash payments). Now let’s take a look and see what would happen if you reinvested those same dividends, with all other factors being equal. When you reinvest the dividends on those original 100 shares and receive share of stock instead of the cash you will end this 20-year period with 180.61 shares of stock still valued at $100 per share for a total value of $18,611. This is the power of compounding interest at work!
Now if you are an investor that perhaps has already met their retirement goals, already in retirement, or simply looking to supplement your income with your investment portfolio. Then taking the cash payment of the dividend would be most beneficial to you. For example, let’s say an athlete has just retired and is in the transition phase of his/her life and is moving on into employment outside of athletics, but is currently unemployed and lacking income. If he/she has a portfolio consisting of dividend paying stocks and had been reinvesting them while playing. It could be beneficial to them to change from reinvesting those dividends to taking the cash payment to give them some liquid income in the interim to help cover current expenses.
Financially stable dividend paying companies are going to be a backbone to any stock portfolio. These companies are typically some of the steadiest performers in the market and have predictable enough profits that they are willing to pay a portion of those profits to you the shareholder. As we have illustrated for those with a long-term investment horizon using compound interest and reinvesting your dividends over time can have significant impacts on your portfolio’s returns. Using dividends is another tool in your investing toolbox to help maximize returns. But remember, you always have to take a deeper dive into the research before investing. Not all dividends are created equal, and just because a stock pays a dividend does not guarantee that it will be a good investment.