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Dividend Stock Basics

An Introduction to Buying Dividend Stocks  

Hereís a novel idea: Buy stocks that pay you to own them! They are called dividend-paying stocks, and you make money, even if they donít go up much.

Better still, stocks with solid dividend prospects donít go down as much as other stocks, because when they try, the resulting dividend yield boost attracts more buyers.

Dividends Defined

Dividends are cash payments that companies make to shareholders, based on the number of shares that they hold. Most U.S.-based companies pay dividends quarterly, that is, every three months. But some pay monthly, while others pay annually or semi-annually (every six months). 

Besides for those periodic payments, companies sometimes declare one-time or special payouts. These could be in addition to the firmís regular payouts, or firms that donít pay regular dividends might declare a special payout from time to time. 

Normally, your broker adds the dividends received from stocks to your cash account. Most brokers, however, also offer automatic reinvestment plans. With these plans, your broker uses the dividends to purchase additional shares, even if the dividend equates to only a fraction of a share. Your broker may not charge for this service. If you donít need the cash for expenses, you should always take advantage of your brokerís dividend reinvestment services.

Dividend Dates Explained

Declaration Date: date that dividend is announced.

Ex-Dividend Date: first day that new buyers are not eligible to receive dividend. Since it takes three business days to be the owner of record, the ex-dividend date is two business days before the "owner of record" date.

Owner of Record Date: date firm uses to determine who gets a dividend.

Payment Date: date dividend is deposited into brokerage accounts.

Dividend Stock Types

Dividend paying stocks fall into three major categories: 1) Federal Corporate Tax Payers. 2) Federal Income Tax Exempt Corporations, and 3) Master Limited Partnerships (MLPs) and Limited Liability Corporations (LLCs).

Federal Corporate Tax Payers: stocks issued by utilities, banks or other financial institutions, or firms that make products or sell services. Their dividends are subject to a 15% or 20% maximum federal income tax rate, depending on your taxable income level. Dividend yields generally top out in the 4% to 5% range.

Federal Tax Exempt: firms granted special status by U.S. laws and donít pay federal corporate taxes as long at they pay a specified percentage of earnings to shareholders in the form of dividends. Their dividends are not subject to the 15%/20% limit and are mostly taxed at ordinary income tax rates. These include Real Estate Investment Trusts (REITs) and Business Development Companies (BDCs). Typical dividend yields 4% to 12%.

MLPs and LLCs: firms that trade on major stock exchanges, the same as regular corporate stocks, but are organized as partnerships. Tax returns are more complicated than for corporations, but taxes of on a sizable portion of dividends (technically distributions) can often be delayed until you sell. Typical distribution yields 5% to 12%.

Dividend Yield Definition

The estimated dividend payouts over the next 12 months divided by the price you pay for the shares. For instance, the yield would be 5% if you pay $20 per share for a stock expected to pay $1 per share dividends over the next 12 months.

Picking Dividend Stocks

Youíll always do best by picking stocks that increase their payouts while you own them. When that happens, your dividend yield increases and the dividend hike often drives the share price higher. Conversely, a dividend cut hurts you two ways. Your yield drops and the dividend cut usually pressures the share price. 

How do you find the stocks most likely to hike their dividends? Strategies for spotting the best candidates vary with industries and with dividend categories. Weíll explore the details in future articles. However, there is one universal truth that applies to all.

History: the Best Teacher

Baring a major management shift, firms with a consistent dividend growth history covering many years are probably committed to continuing that policy. These are always your best candidates. Conversely, companies that havenít consistently increased dividends probably prefer to use their extra cash for other purposes. They will likely disappoint.

See the Dividend Stock Checklist for hints about how to pick the best dividend stock candidates.

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