Investing in dividend stocks: What is it and how do you do it?

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With dividend stocks, it is possible to benefit from a company’s profit in the form of a dividend. Do you want to know how dividend investing works, what to look out for, and if it suits you? Read on and build your insight step by step.

Dividend stocks: meaning in short

Dividend stocks are stocks of companies that distribute profit to shareholders in the form of cash or stocks. Dividend stocks can offer advantages such as passive income and inflation protection, but also involve risks such as dividend suspensions. By paying attention to financial health and diversification within a long-term strategy, investors can ensure wealth growth with dividend stocks. Investing in dividend stocks carries risks.

What are dividend stocks?

Dividend stocks are stocks of companies that distribute a portion of their profit to their shareholders in the form of dividend (cash or stocks). Dividend is a profit distribution and is usually paid out annually, sometimes quarterly or half-yearly.

A stock is known as ‘ex-dividend‘ when the company decides to set a date for payment. If you have invested in the company before the set date, you will receive the promised dividend.

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How do dividend stocks work?

If a company makes a profit, the board can choose to pay out a dividend to the shareholders. The amount of the dividend per stock depends on the profit, the number of stocks you own, and the company’s dividend policy. Dividend can then be paid out in cash (cash dividend) or in the form of new stocks (stock dividend).

It is good to know that paying out a dividend is not mandatory, which is mandatory for bonds, for example. As an investor, you therefore have no right to it. Companies can decide to lower the dividend or not pay it out at all due to financial health, the global economic context, and medium and long-term outlooks.

Why do companies pay out dividends?

Companies pay out dividends with the idea of increasing the demand for their stocks. It can be a signal of confidence in their own financial health. Often these are financially stable, mature companies that have been paying dividends for years, the so-called ‘dividend aristocrats‘ (25+ years) and ‘dividend kings‘ (50+ years), such as Coca-Cola and Procter & Gamble.

Companies can also pay out dividends to reward shareholders for their trust and capital because they have no other use for the profit. This is also known as ‘poverty of ideas’.

What are the advantages of investing in dividend stocks?

Dividend stocks offer several advantages for private investors. These are:

• Regular income: Dividend provides periodic payouts and can contribute to a stable source of income.
• Stability: Dividend stocks are generally seen as a safe investment because a company that consistently pays dividends must be stable to do so regularly.
• Capital growth: Dividend stocks can provide capital growth with the idea that the company continues to grow and more profit is generated.
• Protection against inflation: Dividends can rise along with inflation, maintaining your purchasing power.

What are the disadvantages of investing in dividend stocks?

Dividend investing also involves risks that you must take into account. These are:

• Dividend suspension: Companies can lower or stop dividends to save money. If you are dependent on dividends as income, this can be inconvenient.
• Tax burden: Dividend income is taxable and reduces your total return.
• Less focus on growth: If a company prioritises stable dividend payouts, it may grow less. This can influence the price in the long term.
• Limited diversification: Too much focus on dividend stocks can make your investment portfolio less broad.

Examples of different dividend stocks

Practical examples of dividend stocks are well-known names. Companies in the banking sector such as JPMorgan Chase and Wells Fargo, or in the oil industry like Total and Shell, are known for their regular dividend payouts. Telecommunications is another industry to look at, with companies like Verizon and AT&T. In Europe, German companies particularly stand out: Allianz, for example, or Bayer and Deutsche Post.

Dividend stocks vs. ‘regular’ stocks

Although every stock is technically the same, the company’s strategy determines what type of return you get as an investor. The difference between dividend stocks and ‘regular’ stocks lies in what the company does with the profit: paying it out to the shareholder or reinvesting it in the company. Look at the table below.

The difference between dividend stocks and ‘regular’ stocks

Dividend stocks and funds

In addition to receiving dividends via stocks, you can also receive them through investment funds and ETFs. With dividend funds, you can often choose to have the dividend paid out to your account or to reinvest it. In this way, your invested capital is increased, and you can benefit from so-called compound interest in the long term.

Tip: In our article ‘All you need to know about dividends‘ you will find a list of high-dividend ETFs available on BUX.

Calculating dividend yield and payout on stocks

You calculate the dividend yield by dividing the dividend per stock by the stock price, multiplied by 100%. This is the formula:

Yield percentage = (dividend per stock / stock price) x 100%

The total dividend payout is the gross amount you receive. You calculate the total dividend payout by multiplying the dividend per stock by the number of stocks you own. This is the formula:

Total dividend payout = dividend per stock x number of stocks owned

An example of yield percentage
Suppose you buy a stock for €50 and receive an annual dividend of €2.50. This means the yield percentage is 5% ((€2.50 / €50) x 100%).

An example of dividend payout
You know you receive €2.50 dividend per stock and you own 100 stocks. You therefore receive €250 (100 x €2.50).

Is dividend investing wise?

Whether dividend investing is wise depends on your personal situation and goals. Are you looking for regular income, stability, and a long-term approach? Then dividend investing might suit you. Dividend investing is no guarantee of success, but it does fit within a diverse strategy within investing. But just like with other investment strategies: investing involves risks. You can lose your investment.

How do you select dividend stocks?

When selecting dividend stocks, you look at a company’s financial health, dividend history, growth potential, and dividend yield. Let’s look at these four points.

• Financial health: See if a company is financially healthy, makes sufficient profit, and has stable cash flows.
• Dividend history: A long history of regular dividend payouts can indicate reliability, but offers no certainty.
• Growth potential: See if the company has room to grow profit and dividends in the coming years.
• Dividend yield: Check the company’s dividend yield to see how much is paid out in relation to the stock price.

How can I invest in dividend stocks?

If you want to start investing in dividend stocks, it is advisable to first immerse yourself in the available information about this strategy. It is good to know what dividend, yield, and payout are. You can then proceed with the following nine points:

1. Set your investment goal 

Determine what you want to achieve with dividend investing. Are you looking for a regular income? Do you want to grow your wealth in the long term? Or are you going for a combination of both? Your goal helps give direction to your investment strategy.

2. Check which companies pay dividends 

Not all companies pay dividends. Therefore, research which established companies pay good dividends and in which sectors they are active, so you know what you are looking at.

3. Analyse indicators 

Look at the indicators we mentioned earlier: financial health, dividend history, growth potential, and high dividend yield. These points give you insight into the quality and sustainability of the dividend payouts.

4. Diversify your portfolio 

Spread your investments across different sectors, investment products, companies, and possibly countries. Diversification helps limit risks when dividend payouts or prices of individual stocks are disappointing. Diversification is the key to risk management in any investment portfolio.

5. Choose between stocks or funds 

You can invest in dividends via individual stocks or via funds and ETFs. Funds offer more diversification, while with individual stocks you can choose exactly which companies you want to invest in.

6. Consider reinvesting 

Consider reinvesting the dividend you have received. You essentially buy extra stocks. This can ensure that your future dividend payouts are higher.

7. Keep an eye on your portfolio 

Keep monitoring your portfolio periodically and see if companies maintain their dividend policy and remain financially healthy. Dividend investing does not require daily attention, but it does require regular evaluation so that you can adjust your portfolio if necessary to achieve your investment goal.

8. Take taxes into account 

Dividend income is taxable and can vary depending on the investor’s tax bracket. Tax reduces the net return. Inform yourself about dividend tax, offsetting, and foreign withholdings, especially with international dividend stocks.

9. Be patient 

Dividend investing is a long-term strategy. Results build up gradually via dividend payouts and potential price development. Not via quick profits or short-term decisions. The advice is therefore to remain patient.

Dividend stocks and ETFs at BUX

At BUX, you will find stocks and ETFs that have a solid history of paying dividends to help you make the best choices. You can find this category directly in the BUX app.

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Investing involves risks. You can lose your investment.

All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.