Dividend-paying companies distribute a portion of the net income to the stockholders each year and reinvest the remaining profits back into the business. The payments are usually quarterly though there are companies that pay monthly. Dividend stocks are ideal for various reasons 6 of which include:
1. Generates Passive Income
Dividend-paying companies make regular dividend payouts to the investors and thus it helps them secure a steady source of income. A dividend stock gives a passive income advantage of generating cash on a regular basis with little or no work. Dividends paying companies increase their dividends payouts over time. This makes it a very attractive investment.
2. Maximize Returns Through Reinvestment
Dividend reinvestment is a powerful way that investors can take advantage of the power of compounding to increase income by using their earnings to generate more revenue. You can earn more money through reinvestments without having to invest any additional money from your pocket. This is a perfect way to make your money work for you.
When you use your dividend earnings to purchase additional company shares, you will make extra earnings because every share you add earns its own regular dividend payout.
3. Gain in Two Ways
With dividend stocks, investors have two ways to gain. This is gain from income and capital appreciation. You can profit when the share value rises and when the company pays the dividends. In addition, the blue-chip dividend-paying companies raise their dividends over time and so your income could rise over time.
4. Helpful in Equity Evaluation
Investors can do a better and reliable equity evaluation and stock selection by examining the company’s ability to pay dividends rather than the use of the usual financial ratios. This is because how a company pays dividends to the stockholders is a solid indication of how the company is performing. The financial metrics given by companies can sometimes be manipulated through their accounting practices to improve their appearance to investors. A company has to have a real cash flow to pay the dividends and therefore, evaluating the companies’ current and historical dividend payout gives the investors a reliable point of reference in the basic fundamental analysis of the company’s strength. Consistent dividend payout is an indication that a company is generating profits steadily and it can’t easily be threatened by a temporary market and economic downturns.
5. Reduce Risk and Volatility
Dividends payments help to mitigate any losses that occur from a stock price decline. Most studies have revealed that dividend-paying stocks outperform the non-dividend paying ones’ during the bear market and they report significantly better value than the non-dividend stocks.
The dividend stocks also suffer less volatility compared to the non-dividend stocks over time. Companies that can afford to pay consistent dividends to their investors are stable and thus are more able to withstand economic downturns.
6. Offers Tax Advantages
The way the dividends are treated in regard to tax makes it a perfect investment. The dividend paying stocks benefit from a special rate called the qualified dividend rate and is taxed at lower rates than the ordinary income. When the ordinary income tax rate is 25% or higher, the tax rate of qualified dividends is only 15% according to the IRS regulations of 2011. Dividend special rate can be 0 percent, 15 percent or 20 percent depending on your tax bracket and thus a dividend investment gives you the benefit of retaining more of your dividend income.
The dividend stock is one of the safest investments to make. It may have a few disadvantages but the benefits make it such an ideal investment.