Even if you’ve been investing for decades, income investing can introduce a lot of new lingo and acronyms, which are not always well explained. Here are some of the key terms I use in Cabot Dividend Investor or that you may see as you research your investments further.
CAGR: Stands for compound annual growth rate and is a way of annualizing growth over a multi-year period. If I say a dividend grew at a 16% CAGR, that means it grew 16% per year on average. In reality, it may have grown more or less than 16% in each individual year.
Dividend Reinvestment: If you don’t need income from your investments right now, you can automatically reinvest the dividends. Reinvested dividends will be used to buy more shares at the market rate. This is an easy way to increase the value of your position without doing much. Most brokers will reinvest dividends for you at no cost, or you can use a DRIP.
DRIP: Stands for Dividend Reinvestment Plan and is an alternative way to reinvest your dividends. Companies with DRIPs allow you to buy shares directly from the company, and then reinvest the dividends in new shares automatically, usually at below-market price. They’re a good way to increase the value of your investment quickly, although you do have to buy directly from the company, so it’s not as easy to manage your investments all in one place.
Ex-Dividend Date: The ex-dividend date is the date by which you need to own a stock in order to receive the next dividend payment. It’s called the ex-dividend date because anyone who buys the stock on that date or after is buying it without the dividend, or ex-dividend. (Even though they now own the stock, the person who sold it to them will receive the dividend.)
Ex-Dividend dates are shown in red and italics on our Dividend Calendar. If you’re thinking about buying a new position and want to collect its next dividend, make sure you buy before that red date … not on it.
FCF: Stands for free cash flow. Free cash flow is a more direct measure of cash available to the company than EPS, and since dividends are paid out of cash, I use it sometimes when talking about payout ratios or whether a company can “afford” its dividends. While EPS can give you a good idea of how a business is doing, FCF is usually a better measure of how much cold hard cash the business has on hand for activities like paying dividends and buying back stock.
Payment Date: The Dividend Payment Date is the day the dividend will actually be paid and show up in your brokerage account. You have to buy the stock before the ex-dividend date to receive the payment. Dividend payment dates are shown in green on our Dividend Calendar, so stockholders will know when they’re getting their dividend checks (or deposits).
Payout Ratio: The payout ratio is the percentage of earnings paid out as dividends, calculated by dividing the stock’s dividend per share by EPS. A low payout ratio is good; it shows that the company’s dividend payments are well covered by its earnings, so they’re not in danger. In addition, it means the company is holding plenty of cash back to reinvest in the business, ensuring the security of future dividend payments. On the other hand, a high payout ratio can be a red flag that a company is having a hard time affording its dividend payments, especially if the payout ratio is historically high for that company. Companies that pay out a large percentage of their cash also have less cash to reinvest in growing their business.
Some companies can maintain higher payout ratios than others, so we also consider company’s historical payout ratios and the trend of a company’s payout ratio. And some types of businesses, like MLPs and REITs, will always have very high payout ratios (often over 100%) and need to be evaluated differently.
Qualified Dividends: The U.S. government taxes dividends at a lower rate than regular income (currently 15%). However, the dividends have to be qualified. Most regular dividends paid by regular companies (U.S. or foreign) will be qualified, but most distributions paid by tax-advantaged entities like MLPs, REITs, BDCs and some CEFs will not.
Record Date: The Record Date is the day, usually about four weeks before the payment date, when a company pulls the list of current shareholders who are eligible to receive their next dividend, called “shareholders of record.” However, you need to buy the stock before the ex-dividend date in order to be counted as a shareholder of record.
ROC or Return of Capital: Distributions that are considered a return of capital reduce your cost basis in an investment. You don’t have to pay taxes when you receive them, but when you sell the investment, you have to pay regular income taxes on the difference between your original cost basis and your adjusted cost basis. See your MLP guide for some examples of how this can work. While most MLP distributions and some BDC distributions are considered return of capital, it’s often a red flag if a regular company or a CEF makes a distribution that’s partially return of capital. This can signal that the company or fund didn’t make enough cash to cover its distribution, so they’re covering the difference by “returning” some of your capital.
Total Return: I report total return in our portfolio overview, rather than just price appreciation, because it includes dividends earned. It’s equal to the total appreciation of your investment, including price appreciation and dividend payments.
Yield: Yield is the percentage of its value an investment generates every year. It is equal to an investment’s annual dividend per share divided by its price per share. If you own a $1,000 investment that pays you $20 per year in dividends, your yield is 2%.
Yield on Cost: Yield on Cost is the yield you’re receiving from your income-generating investments. It’s equal to the annual dividend per share divided by your average cost basis per share. If you’ve held an investment a while and its price has gone up, your yield on cost is likely significantly higher than the current yield.