Dividend investing is a big part of many investors' strategies, and most people who invest in dividend stocks know basic terms like "dividend yield." However, there are a lot of dividend terms that aren't as well-known by investors.
Here are three terms our analysts want you to know that can help you understand more about how your dividend stocks work -- and could help you make better investment decisions.
Matt Frankel: One dividend term all investors should know (and use) is DRIP, which stands for "dividend reinvestment plan."
Basically, when you enroll in a dividend reinvestment plan, which you can do through your brokerage, all of your dividends are used to buy more shares of that stock. You can even buy fractional shares, so your entire dividend payment gets reinvested.
For example, let's say that you own 50 shares of AT&T, which trade for $32.75 as of this writing. So, your quarterly dividend payment of $0.47 per share translates to a total dividend of $23.50. Without the DRIP, this isn't even enough to buy one more share, but the dividend reinvestment plan actually will use that dividend to buy 0.72 shares of AT&T stock. You now own 50.72 shares, which will earn more dividends next quarter, which will then be used to reinvest in even more shares.
This is beneficial for a few reasons. First, as I mentioned before, you can buy fractional shares, which means that 100% of your dividend income is immediately put to work for you. Second, and just as important, the DRIP lets you invest without having to pay commissions. Even at $9.99, this saves you nearly $40 in commissions per year on a stock that pays quarterly dividends.
If you haven't done so already, check with your brokerage about enrolling your stocks in a DRIP. It can supercharge your long-term returns and save you money now.
Dan Caplinger: Some of the most confusing terms about dividends involve how they get paid. There are three main dates you need to know: the record date, the ex-dividend date, and the payment date. The easiest to understand is the payment date. That's the date on which proceeds will get credited to your brokerage account, or sent to you by check.
Where people get tripped up most often is with the record date and ex-dividend date. In order to qualify to receive a dividend payment, you need to have been a registered shareholder on the record date. However, those who buy or sell shares near the record date need to take into account the three-day settlement period for trading stock. If you buy the stock three business days before the record date, your trade will settle in time and you'll be a shareholder of record and receive the dividend. However, if you buy the stock two business days before the record date, your trade won't settle until after the record date, so you won't get the dividend.
Because of this, the day that's two business days before the record date is typically called the ex-dividend date, as it's the first day on which the stock trades without the dividend -- also known as ex-dividend. Adding to the confusion is that for certain special dividends, the rules are different, and the stock often trades ex-dividend on the day after the dividend is paid. Overall, though, understanding the theory behind these dates should tell you what you need to know about buying or selling a dividend stock.
Jason Hall: One of the most important dividend terms is a metric that can help you make sure a dividend is sustainable: the payout ratio.
In short, this is the ratio of earnings that a company pays out in dividends. Here's how it looks for three well-known dividend-paying companies, ExxonMobil, American Express, and Nucor:
AmEx and ExxonMobil have been able to regularly increase their dividends since they are a much smaller chunk of earnings, but Nucor's payout has only been increased by pennies per year over the past five years. The company pays a large percentage of its earnings as dividends already, and it operates in a cyclical business: steelmaking. It has even gone through periods where it was paying out a larger dividend than total profits. That's not sustainable over the long term.
A single year or two of high payout ratios isn't necessarily bad, but the closer the payout ratio is to 100%, the harder it can be for a company to grow it. If you're looking for consistent long-term dividend growth, companies with lower payout ratios are usually able to grow payouts at a higher rate. This can really pay off years down the road.
