Building Wealth with Dividends

Every Friday morning, I discuss different aspects of investing and retirement planning. The hosts of MomsMakingaMillion Talk Radio believe that if women were paid what men are paid for the same job, poverty in this country would decrease by 50%. This week, on 11.20.09, we will be discussing the art of dividend investing. (The format for my segment is broken down into five questions.)

So what are dividends?
When a company makes a profit there are basically three things that can be done. Some reinvest it, which is what newer companies or growth companies do. They take those profits and channel them back into the company in the form of research or simply hold the cash for future mergers and acquisitions. Some companies use the money to buy back their own shares. This happens when the company realizes that its share price is below what they think it should be. Some use the cash to clear up their balance sheets by buying down their debt exposure. Others share it with the shareholders.

These are all good things to do with the cash they have made but nothing benefits the shareholder over the long run better than dividends do. Why is that?
Dividends are old school. I wasn't that long ago that Wall Street considered the act of dividends the most important aspect of an investment. Now we can look to dividends for one thing: to increase our wealth.

How often do companies pay their shareholders?
Dividends are decided by the board of directors. Then they set a declaration date, which is the day the dividend payment to shareholders becomes a liability on the company's books. This is followed by the shareholder of record date. If you are holding the stock on that date, you receive the payment. They refer to this point in time as the ex-dividend price for the stock. If you buy the stock before the dividend is paid, you get the dividend. But be careful, a company considers the shareholder of record a person who owns the stock four days before the dividend is actually issued. Buying a stock in this four day period means you will not get the dividend; the person who sold it to you will. And the other important date in this process is when the company actually pays you.

Do they always pay cash?
This is the most common way of doing it. A company will declare a dividend and that amount usually is split among four quarters. So if the business offers you a dollar dividend, each quarter you would receive 25 cents for each share you own. Sometimes they offer a one time special dividend which is a lump sum payment with no other date specified when they will do this again.

What do investors need to keep in mind when buying dividend paying stocks?
Three thing investors can keep in mind when looking a dividend paying stocks: they are less volatile because the companies who pay them tend to be far more stable in terms of share price than other companies, they outperform non-paying dividend companies by almost 3%, and the are easily reinvested providing the investor with additional opportunity to buy more stock which means more dividends.

Paul Petillo is the Managing Editor for BlueCollarDollar.com and a fellow Boomer