Let’s say that a corporation provides natural gas for heating and cooking to homes on a populated island through a network of pipes laid under the island’s streets. The company is in an interesting situation. On the down side, it doesn’t have opportunities to grow. On the upside, it doesn’t have much competition. For a would-be competitor to tear up all the streets on the island to lay gas pipes next to the company’s existing ones would be too costly.
So, what’s the company to do with the profits it consistently earns? The decision most of these companies make is to pay out a significant percentage of it to their shareholders who are, after all, the owners of the corporation. These payouts to shareholders are known as dividends. Holders of these corporations’ stocks go to their mailboxes four times each year (the number of times dividends are normally paid) and retrieve checks that represent significant income!
To determine whether a corporation is paying a substantial dividend, just divide the annual dividend the corporation pays by the price of a share of its stock. For example, if XYZ Corporation is paying $2 in dividends per year and its share price is $50, 2/50 * 100 (to make it into a percentage) equals 4%. This is called the corporation’s dividend yield.
| Suitable for | Retirees, those who need their invested money to earn (and pay them in cash) as much as possible. Because income corporations are well-established in their industries, they have a low chance of suffering major drops in their share prices because of a threat to the business, something retirees can ill afford. | |
| Examples | Utility corporations National Grid (NGG) and Duke Energy (DUK). | |
| In the news | 23 Dividend Cuts and Suspensions Chalked Up to the Coronavirus – April 23, 2020
Why Mattel is the ‘Top Dividend Stock of the Nasdaq 100’ With 4.9% Yield (MAT) – November 20, 2014 How to Pick Dividend-Paying Stocks – October 18, 2012 MSFT Named ‘Top Dividend Stock of the Nasdaq 100’ at Dividend Channel With 3.0% Yield – November 4, 2011 |
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| Connections | An income corporation is the opposite of a growth corporation. | |
| Explorations | 1. Is a really high dividend too good to be true? While doing research you may come across a corporation whose dividend yield is very high, perhaps 15%, 20% or more. It seems like you’ve discovered an amazing investment. However, you may be about to step into a trap. Informed investors may be selling their shares, driving the price down. The share price is the denominator of the dividend yield equation, so when it goes down, the yield goes up. Why would anyone sell the shares of a corporation that is paying such a relatively high dividend? They may know that because the corporation is doing poorly, perhaps even losing money, it will have to cut the amount of the dividend, perhaps dramatically. That incredible dividend yield you’ve discovered can disappear over night. A great exercise is to find corporations whose dividend yields are very high (15% or more). Read news about them, and try to figure out why their yields are so darn high!2. When established corporations cut their dividends Dividends are a benefit that shareholders come to rely on. Companies never want to reduce the dividend, which shows that the company can’t be relied upon. Therefore, when an established corporation does cut it’s dividend, this means that times are really bad and that it is taking extreme measures to preserve its cash. What were the circumstances around the decision of the following corporations to cut their dividends? GE slashes 119-year old dividend to a penny – October 30, 2018 GE cuts dividend for second time since Great Depression – November 13, 2017 Post Earnings Coverage as Ferrellgas Partners Announces Dividend Cut to Maintain Leverage and Replaces CEO – September 30, 2016 Seadrill Plunges on Dividend Suspension as Rig Market Sours – November 26, 2014 3. What do the Canadians offer that’s so special? 4. Doubling down with dividends |
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| A final word
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The lockdowns implemented to combat Covid-19 have devastated many businesses. While reluctant to do so, many corporations have made the decision to cut their dividends and preserve whatever cash they can.
Finally, some financial advisors and investing newsletters focus exclusively on income investing, finding corporations whose shares not only have a high yield, but which also have a history of raising the dividend every year. They’ve been called by the financial press Dividend All-Stars and Dividend Aristocrats. |