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What are dividends and dividend yield

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What is a dividend?

Dividends represent a portion of the net profit that stock corporations pay out to shareholders as part of the profit distribution. There are several types of stock dividends:

Stock dividend: The term is derived from the English term “stock” for stock. In the case of stock dividends, shareholders do not receive a cash payment, but rather additional company shares.

Cash dividend: In this case, shareholders receive a direct, pro-rata distribution of profits. The cash amount is determined beforehand at the general meeting.

Dividend in kind: Shareholders can, for example, receive shares from subsidiaries or “real” material assets, such as products manufactured by the company.

In general, dividends are a kind of bonus for shareholders, as they provide capital to the corporation. The difference to fixed-income investments: dividends are usually only paid if the company has made a profit. And even then, stock corporations usually only pay out part of the profit to their shareholders.

GOOD TO KNOW: Other forms of company,  pass on profit shares to the co-owners. Here, however, we do not speak of dividends, but of a profit distribution.

DIVIDEND PAYMENT

The dividend for the past financial year will be decided on the day of the general meeting. With the resolution of the general meeting, the value of the share is reduced by the dividend amount. One often speaks of the dividend discount. When the price is quoted on the next day, this discount is indicated by the addition “Ex dividend”. Shareholders receive the cash dividend directly by transferring them to their own account. However, after the annual general meeting, it can take several weeks or even months for shareholders to actually receive the amounts.

Many investors are guided by particularly high dividends when buying shares. But stock market professionals often interpret a high dividend yield as a warning sign. Because when there are economic problems, the share price drops. However, this also increases the dividend yield and attracts investors with a supposedly attractive value.

GOOD TO KNOW: the dividend yield cannot be compared with interest investments. Due to the several factors play a role in the return. For example, dividend payments can be suspended in the event of economic difficulties. In addition, the share price can also fluctuate, which in turn affects the dividend yield. Interest investments, on the other hand, are more stable because investors receive a fixed rate of interest for a fixed term. Due to the low interest rate policy, however, only low interest rates are offered for investment capital, which is why more and more investors are relying on the dividend yield.

DIVIDEND YIELD RISKS

A high dividend yield is only partially meaningful. Because there can be several reasons for increasing returns – and not all are positive.

  • The dividend rises sharply in percentage terms, the share price a little less.
  • The dividend rises, the share price remains constant.
  • The dividend stagnates, but the share price is falling.
  • The dividend goes down, but the stock price goes down even more.

WHAT DO DIVIDEND INVESTORS LOOK OUT FOR?

For many investors, looking at the current dividend amount and dividend yield is not a sufficient selection criterion. Many investors even see unusually high returns of over 6% as a warning sign. Because they are often based on extraordinary, mostly negative circumstances. Exchange professionals therefore pay attention to other criteria in addition to the return. The return first shows what percentage of the company’s profit is distributed as dividends. If all profits go into dividends, there is nothing left to invest in growth. The result: increasing corporate profits (and distributions) can hardly be expected in the future.

Depending on the industry, professionals prefer payout rates of around 50%. These distribution rates should be kept constant by the company over longer periods of time. The business development and profit development of companies must allow an attractive stock dividend. Solid balance sheets and established business models are essential for this. Companies should achieve good profit margins even in economic downturns. Therefore, market leadership and pricing power of companies are important criteria for dividend-oriented investors. More important to investors than the absolute amount of the dividend is the consistency with which it is paid. The scrip dividend should never fail, at least be constant and, if possible, even increase regularly. Companies that meet these conditions are called dividend aristocrats in stock market jargon.

INVESTMENTS BY FUND OR ETF?

A more detailed analysis of the dividend strategy shows that a mechanical selection of stocks according to the dividend yield is not enough for investment success. This is why many shareholders forego the individual security selection and rely on dividend ETFs or dividend funds. Passively managed ETFs on dividend indices, however, usually have one disadvantage: They mechanically rely on the stocks with the highest dividend yield. In the past, however, they could not avoid falling prices in high-dividend but weak financial, telecom or energy stocks. Active fund managers have it easier. You can increasingly rely on profitable consumer stocks, stable corporations and also on profitable technology stocks that have significantly increased their dividends in recent years and whose prices have risen at the same time. As a rule, however, these types of funds are also more expensive. Funds with a dividend focus have now been launched for almost all regions of the world.

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