Understanding Dividends
Dividends are cash payments (or sometimes additional shares) that a company distributes to its shareholders. Dividends can be a powerful component of total return — but only if they are sustainable.
Dividend Basics
What a Dividend Really Is
A dividend is typically paid from a company’s free cash flow or retained earnings. Dividends are not guaranteed, and companies can increase, reduce, or suspend them.
Key Dates
- Declaration date: Company announces the dividend amount
- Ex-dividend date: Cutoff to receive the dividend
- Record date: Shareholders on record receive the dividend
- Pay date: Dividend is paid
Dividend Yield
Dividend yield is the annual dividend divided by the share price.
``` Dividend Yield = Annual Dividend / Stock Price ```
Interpreting Yield
- Very high yield can be a warning sign (price may have dropped because investors expect a cut)
- Low yield can still be attractive if dividend growth is strong
Payout Ratio (Sustainability Check)
Payout ratio measures how much of earnings are paid as dividends.
``` Payout Ratio = Dividends / Net Income ```
Many analysts also look at a cash-based payout ratio:
``` FCF Payout Ratio = Dividends / Free Cash Flow ```
What’s “Good”?
- Stable sectors (utilities, consumer staples) can support higher payout ratios
- Cyclical businesses often need lower payout ratios to stay safe in downturns
Dividend Growth (The Compounding Engine)
Dividend growth strategies focus on companies that steadily increase payouts over time.
Why Growth Matters
- Your yield on cost can rise over years
- Dividend increases often signal business strength
Common Dividend Traps
- Chasing yield without checking cash flow
- Ignoring debt levels (dividends compete with interest payments)
- Overlooking cyclicality (dividends may be cut in recessions)
Quick Dividend Checklist
- Payout ratio reasonable for the sector
- Positive and stable free cash flow
- Manageable debt and interest coverage
- Track record of dividend growth (optional)
- Business model with resilient demand
Conclusion
Dividends can be a reliable source of income, but the best dividend stocks are the ones that can keep paying — and keep growing those payments — across a full business cycle.