When interest rates reach historic lows, some investors in search of income-generating investments turn to dividend-yielding stocks. Dividends are taxable payments made by a company to its shareholders. When a company makes a profit, that money can be put to two uses:
- Reinvested in the business
- Paid out to the company’s shareholders in the form of a dividend
Dividend RatiosInvestors track dividend-yielding stocks by examining these two ratios: Dividend per share measures how much cash an investor is scheduled to receive for each share of dividend-yielding stock. It is calculated by adding up the total dividends paid out over a year (not including special dividends) and dividing by the number of shares of stock that are outstanding. Dividend yield measures how much cash an investor is scheduled to receive for each dollar invested in a dividend-yielding stock. It is calculated by dividing the dividends per share by the share price.
Other Dividend ConsiderationsInvesting in dividend-paying stocks can create a stream of taxable income. But a company paying dividends is only one factor to consider when choosing a stock investment. Dividends can be stopped, increased, or decreased at any time, unlike interest from a corporate bond, which is normally a set amount determined and approved by a company’s board of directors. If a company is experiencing financial difficulties, its board may reduce or eliminate its dividend for a period of time. If a company is outperforming expectations, it may boost its dividend or pay shareholders a special one-time payout. When considering a dividend-yielding stock, focus first on the company’s cash position. Companies with a strong cash position may be able to pay their scheduled dividend without interruption. Many mature, profitable companies are in a position to offer regular dividends to shareholders as a way to attract investors. Dividend income is currently taxed at a maximum rate of 20%. Be cautious when considering investments that pay a high dividend. While past history cannot predict future performance, companies with established histories of consistent dividend payment may be more likely to continue that performance in the future. In a period of low interest rates, investors who want income may want to consider all their options. Dividend-yielding stocks can generate taxable income but, like most investments, they should be carefully reviewed before you commit any dollars. Keep in mind that the return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost.
Dividends Can Make a DifferenceThis chart shows the role dividends have played in stock market performance during the past 35 years ending December 31, 2016.
Thomson Reuters, 2017.
The S&P 500 Composite Index and S&P 500 Composite Index (Total Return) are unmanaged indices that are generally considered representative of the U.S. stock market. Index performance is not indicative of the past performance of a particular investment. Past performance does not guarantee future results. Also, individuals cannot invest directly in an index.