What is a Dividend?

Want to get paid for investing? Look for a stock that offers a dividend.

Outside of your job, you probably don’t get paid for most of the things you do. But investing in a stock that pays a dividend is one of the exceptions. When you buy a dividend stock, the company will pay you for owning it. And that’s outside any increase (or decrease) in overall stock price.

But what is a dividend? A dividend is a bonus. An extra. It’s a portion of earnings that the company pays to investors on a quarterly or yearly basis.

Here’s the thing about dividend stocks, though. Some people say dividend stocks aren’t sexy. They bore the bejesus out of people. People get turned off by a boring dividend stock.

They shouldn’t. Over time, dividend stocks vastly outperform stocks that don’t pay dividends. When you buy a dividend stock, you know for sure that you’ll receive a steady stream of income. If the market crashes and the share price begins to fall, you at least have a nice 3% or 4% yield (or higher) to soften the blow.

In fact, the best dividend-paying stocks can help you reach a variety of investment goals, including protecting your wealth, generating income and reaping capital gains. Let’s break that down.

Buying a stock that doesn’t pay a dividend can only reward you in one way: share price appreciation. Dividend investing, however, grows your wealth in three ways.

First, like with any stock, your portfolio increases as the price of the stock appreciates. Second, you will receive an income stream of dividend payments, which you can collect in cash or reinvest to further boost your holdings. Lastly, many companies increase their dividends over time, providing an income stream that often outpaces inflation, and greatly increasing the yield the longer you hold the investment. (Your yield is how much you earn in income every year as a percentage of your investment.)

Furthermore, companies that have the cash flow to pay regular dividends typically make safer, more reliable investments. The best dividend-paying stocks are high-quality, long-lived companies with predictable business models—they aren’t going to suddenly crash due to a lousy quarter or an adverse news event.

Bear in mind, however, that the first thing to consider regarding a high dividend, or any dividend for that matter, is whether it is safe and sustainable. Often times, a yield becomes high because the stock price has fallen considerably. A stock price usually falls because of poor operational performance, which imperils its ability to sustain the dividend.

It is generally not wise to be allured by a 8%, 9% or 10% yield on a stock that will have difficulty maintaining the dividend and is less likely to grow it. Over time, you should fare much better with a more modest high yield on a company that can sustain the payout and likely grow it over time.

To learn more about investing in dividend stocks, be sure to download your FREE copy of our report, Cabot’s 5 Best Dividend Stocks.