DGI Lesson 1: What is a Dividend?

This is the first of a series of articles that will lay a foundation for dividend growth investing.

Each article will present one point, one lesson.

Each will be like a brick in a foundation. When we have enough bricks, we’ll have our foundation for why you may want to consider a dividend growth investing strategy.

I want to state at the beginning that I view dividend growth investing as simply an unemotional strategy to achieve certain investment goals.

I know that some people get emotional about different investment strategies, both positively and negatively, becoming almost religious in their intensity.

I’m not like that.

I view investing as a business, and so I take a businesslike approach to it.

That means heavy reliance on facts (“friendly facts”), logical analysis, and intelligent conclusions.

That does not mean that there is no subjectivity. In dividend growth investing, as in life itself, judgments must be made when there are no absolute facts.

My approach to making investment judgments is similar to what I do at the poker table. I try to use whatever information is available to tilt the odds in my favor.

If I can’t be 100% sure about something, perhaps I can be 75% sure. That’s better than a coin flip, and much better than a hot tip. This “odds-on” approach is precisely why I like dividend growth stocks.

The first brick in the foundation of dividend growth investing is to understand what dividends are.

Dividends are distributions by a corporation to its owners.

Usually, what is distributed is money… cash. Occasionally, dividends are paid in shares rather than cash.

Here’s how it happens…

A company’s management will propose the payment of a dividend to its board of directors. If the board approves, a public announcement will be made.

The announcement will specify three things:

  • the amount of the dividend;
  • the record date, meaning the date on which a shareholder must be registered on the company’s records to receive the dividend; and
  • the payment date.

Here’s what a typical dividend announcement looks like. It came on February 7, 2013 from Hasbro (HAS), a dividend growth stock that I own:

“Hasbro’s Board of Directors has declared a quarterly cash dividend of $0.40 per common share. This represents an increase of $0.04 per share, or 11%, from the previous quarterly dividend of $0.36 per common share. The dividend will be payable on May 15, 2013 to shareholders of record at the close of business on May 1, 2013.”

We can learn a lot from this little announcement…

The Amount of the Dividend — Hasbro will raise its dividend from $.36 per share to $.40 per share. This means that if you currently own 100 shares of Hasbro, instead of collecting the $36 that was distributed last time you will collect $40 with the new payout. That’s an 11 percent increase from last time.

As you might guess, dividend growth investing places a lot of emphasis on companies that regularly raise their dividends. In fact, I ONLY invest in stocks that have increased their dividends for at least five years in a row. In future lessons, I’ll explain why.

The Frequency of the Dividend — Hasbro pays its dividends quarterly.  This is quite common (but not universal) for U.S. companies. Some companies pay dividends monthly, while others (especially overseas companies) pay semi-annually or annually.

The Record Date —  In its announcement, Hasbro establishes a record date of May 1, 2013.  This is the day that you must be in the company’s books as the owner of record in order to receive the dividend. Under stock exchange rules, trades must clear within three business days of the order’s execution. Therefore, to ensure that you’re in the record books in time to receive the dividend, you need to buy the stock at least three business days before the record date. In this example, three business days before May 1, 2013 would be April 26, 2013 (or earlier).

The Payment Date — Quite a bit of time can pass between the declaration of a dividend and its payment. Hasbro’s press release was issued in early February. It establishes a payment date of May 15. So more than three months will pass between the announcement of the dividend and its payment. There is no uniformity to how much time may pass between the declaration and the payment. Sometimes it is just a week or two, while other times, as in this example, it’s two or three months.

An important date that’s not mentioned in this announcement, but that you certainly want to pay attention to, is the Ex Dividend Date. That’s because the ex dividend date determines who gets the next dividend. For example…

  • If you buy on or after the ex dividend date, you will not receive the next dividend.
  • If you sell before the ex dividend date, you will not receive the next dividend.
  • If you sell on the ex dividend date, you (not the buyer) will receive the dividend, even though you no longer own the stock by the time the payout date rolls around.

As you can see, the ex date (as it is often called) is two business days back from the record date. It is the day after the last date that you can buy the stock in time to receive the dividend. Starting on that date, the stock trades without the right to receive the upcoming dividend (“ex” means “without”).

If all of this sounds confusing, perhaps this annotated calendar can help…

As you can see, if you’re purchasing or selling a stock near the record date specified in the declaration, it’s worthwhile to double check the ex dividend date to make sure you’re eligible to collect the next dividend.

A stock’s ex dividend date can be easily found on free financial sites like Yahoo! Finance. Also, Daily Trade Alert recently started a free “Ex-Dividend Watch” service for its readers, which identifies stocks that have grown dividends for at least five years in a row and that are about to go ex dividend in the week ahead.

Coming Up Next…

That completes this first lesson in dividend growth investing. Now we know what a dividend is. There’s a lot more to learn about dividends, but this gives you the first brick in the foundation.

In upcoming articles, we’ll explore subjects such as why companies declare dividends… how they determine how much to distribute… and a whole lot about dividend growth.

I look forward to writing this series. It will give me the opportunity to return to basic concepts, the blocking and tackling of the stock investment strategy that I follow.

That will be good for me, and I hope that you, the readers, will find it helpful and educational in your journey toward generating a lifetime of safe, steadily-rising dividends.

Dave Van Knapp
Author of Top 40 Dividend Growth Stocks