When a company makes a lot of profit, it sometimes shares a part of it to its investors. We call it dividends. To put it in a perspective, imagine a “carinderia” business in which you and your mom are the owners. Your supermom does everything from cooking, serving and dish washing while you on the other hand goes to work in a 9-to-5 day job. At the end of the day, a part of its profit goes to your pocket even if you aren’t involved in the day-to-day management of the business. In the stock market, owning shares represent company ownership and the dividend is your “cut” in the company’s profits just like the carinderia business.
What is dividend investing?
Building wealth through dividends introduces us to a different type of investing strategy called Dividend Investing. The concept of dividend investing is to build an enormous portfolio of high yield dividend paying stocks. It’s like investing in many carinderias and taking a portion of its profits in every single one of them on a yearly basis. Dividend investors buy many shares of blue chip stocks that pays high dividends and enjoy a steady stream of cash flow year after year.
If you plan to build wealth on stocks using dividends, you should look for these 3 things;
High Dividend Yield.
When interpreting dividend yield, it is important to understand the concept of it. Dividend yield tells an investor how much his money earns in dividends based on its stock price. Here’s an example; Megaworld Corp. (MEG) pays a dividend of 0.06 Php and the stock’s price is 4.65. To compute for the dividend yield, we divide the dividend and the stock’s price and multiply by 100 to get its percentage.
MEG’s % Dividend yield = (0.06 / 4.65) x 100
MEG’s % Dividend yield = 1.29%
If you invest 100,000.00 Php in MEG, you’ll get a dividend amounting to 1,290.00 Php. For dividend investors, this is quite low. For comparison, let’s see the dividend yield of TEL, one of PSEI’s high paying dividend stock. TEL pays a dividend of 130.00 Php and the stock’s price is 2,756.00 Php.
TEL’s % Dividend yield = (130.00 / 2,756.00) x 100
TEL’s % Dividend yield = 4.72%
Investing 100,000.00 Php in TEL gives us a dividend of 4,717.00 Php. This is a much better investment compared to MEG. So in choosing dividend stocks, look for high dividend yields. One good advice is to find a dividend yield that is higher than current interest rates of retail treasury bonds just like the equity bond theory on capital gains.
Dividend Payout Ratio.
Dividend payout ratio is the ratio of the company’s dividend payments versus the reported net income. In 2014, MEG paid a total of 1.214B Php worth of dividends to its shareholders out of the company’s 24.675B Php net income. To compute for the Dividend Payout Ratio, we divide the total dividends paid by the reported net income;
MEG’s % Dividend Payout Ratio = (1.214B / 24.675B) x 100
MEG’s % Dividend Payout Ratio = 4.92%
What this tells us is that MEG paid out 4.92% of its net income to its investors last year.
Now let’s see TEL’s dividend payout ratio. TEL paid 39.9B Php in dividends and its reported net income is 44.148B Php last year.
TEL’s % Dividend Payout Ratio = (39.9B / 44.148B) x 100
TEL’s % Dividend Payout Ratio = 90.38%
TEL paid out 90% of its income to its shareholders. That’s a very high amount! One general rule is to not exceed 60% as anything higher may mean that the company might not have enough growth opportunities. But sometimes, there are companies that are so much profitable that they don’t almost need their entire yearly net income to grow just like TEL.
Blue Chip Stocks.
If you plan to invest in dividend stocks, then blue chip companies are your solid bet. These companies are the mega giants and leaders in the field and therefore may give you recurrent dividends in the years to come. Companies with steady dividend payouts for the past 10 years should be considered.
Now, take your calculators and compute those dividend yields and dividend payout ratios and determine if your stocks are good investments using Dividend Investing Strategy.
Happy investing!