Dividend Growth Investing Lesson 1: What is a Dividend?

Note from DTA: We are happy to announce that Dave Van Knapp is revising his popular Dividend Growth Investing Lessons. The original 19 lessons were written from 2013 to 2017. They are all still pertinent and correct, but this 2018 project to rewrite the lessons will allow Dave to update information, provide fresh examples, and clarify the lessons. This project also allows us to introduce newer readers to the important fundamental concepts that are the foundation for dividend growth investing.

Dividend Growth Investing Lesson 1: What is a Dividend?

I am happy that DTA requested that I renew the Dividend Growth Investing Lessons. Most of them are now several years old, and while the principles are timeless, the examples need refreshing, and some technical details have changed.

I will also look for better ways to express the essential ideas about dividend growth investing.

Each lesson presents a general principle, then fleshes it out with examples, details, and explanations. Every lesson is presented in plain English and summarizes its key takeaways at the end.

I would urge you to consider each lesson as a block in a foundation.

After we’ve laid enough blocks, we’ll have a complete understanding of what dividend growth investing is and how it works.

As you read the lessons, remember that your personal investing is actually a small business, and you should treat it as such.

That means placing heavy reliance on facts, analyzing them logically, and reaching intelligent decisions.

It also means removing unhelpful emotions and influences from your process to the extent that you can.

Many people fear investing, but there’s really no need for that. Basic knowledge goes a long way to stripping the mystery away. These lessons will help you get started by presenting basic facts, definitions, explanations, and examples.

OK. Let’s get started with the first lesson. We need 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 proposes the payment of a dividend to its board of directors. If the board approves, a public announcement is made.

The announcement will specify at least 3 things:

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

Here’s what a typical dividend announcement looks like. This one came on January 2, 2018 from Johnson & Johnson (JNJ), a stalwart dividend growth stock that I own.

We can learn a lot from this little announcement…

The Amount of the Dividend — JNJ will pay its shareholders $0.84 in cash for each share that they own. So if you own 100 shares of JNJ, your total dividend payout will be $84.

The Frequency of the Dividend — JNJ announced its dividend “for the first quarter.” Most companies pay dividends on a regular schedule. A quarterly schedule is quite common 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, JNJ establishes a record date of February 27, 2018. This is the day that you must be on the company’s books as the owner of record in order to receive the dividend. Companies also use this date to determine who is sent proxy statements, financial reports, and other information.

The Ex-Dividend Date – Once the company sets the record date, the ex-dividend date is established based on stock exchange rules. It is usually one business day before the record date.

That’s the case in JNJ’s announcement. The ex-dividend date is February 26, and the record date is one business day later (February 27).

The ex-dividend date is important, because it determines who gets the next dividend. Beginning on the ex-date, shares change hands without the right to receive the upcoming dividend (“ex” means “without”).

For the buyer of a stock:

• If you buy before the ex-dividend date, you’ll get the dividend.
• If you buy on the ex-dividend date or later, you will not receive the next dividend. There is not enough time to get your name on the company’s books as the owner of record, so the seller gets the dividend.

And if you’re selling a stock:

• If you sell on the ex-dividend date, you’ll get the dividend, even though you no longer own the stock by the time the payout date rolls around.
• If you sell before the ex-dividend date, you will not receive the dividend. The new owner’s name will replace yours on the company’s records, and they will get the dividend.

Sometimes the dividend announcement won’t specify the ex-date, because the date is determined by stock exchange rules once the company sets the record date. Popular research sites give the ex-dividend date, because it is so important.

Here is how JNJ’s dividend dates appear on Morningstar. Notice that in this summary they omit the record date, because the ex-dividend date is more important to investors.

The Payment Date — Quite a bit of time can pass between the declaration of a dividend and its payment. In our example, JNJ’s declaration was announced on January 2, but the payment will not be made until March 13.

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 2-3 months.

Putting all the dates together, this how JNJ’s schedule of dividend events looks. This is a typical illustration of spacing between dates.

One thing you won’t learn from a dividend announcement is the stock’s yield. The reason is that the company does not control the yield. The company controls the amount it pays out. But yield is the ratio of that amount to the stock’s price, which is controlled by the market, not the company.

For example, say a company is paying $1.00 in dividends this year. If its stock’s price is $10 per share, its yield would be $1 / $10, or 10%. But if its price is $20 per share, its yield would be $1 / $20, or 5%.

Usually, in a stock summary, its dividend is stated as a yield (like 5%), not an amount (like $1). Just remember, though, that the yield is a calculated figure that depends on the stock’s price. That’s why a company’s yield changes every day, because the stock’s price is changing every day in the market.

And that’s the end of Lesson 1! Now we know what a dividend is.

Key Takeaways from This Lesson

1. A dividend is a distribution by a company to its owners. It’s usually a cash distribution.
2. Dividends are proposed by management and declared by the board of directors.
3. Management specifies the amount of the dividend, the record date, and the payable date.
4. Stock exchange rules determine the ex-dividend date once the record date is known. The ex-date is important, because it determines who receives the next dividend. If you buy a stock before the ex-dividend date, you’ll get the dividend. If you wait until the ex-date or after to buy the stock, you won’t get the next dividend.
5. A stock’s yield is its annual dividend amount divided by its price. Most yields change every day as the stock’s price changes in the market.

Coming Up…

There’s a lot more to learn, but knowing what a dividend is gives you the first block in the foundation of dividend growth investing.

In upcoming lessons, we’ll explore why companies declare dividends… dividend growth… dividend reinvestment… and how to find great dividend stocks.

These lessons give me the opportunity to share the basic blocking and tackling of the stock investment strategy that I follow. I hope that you, the readers, will find these lessons helpful and educational in your journey toward generating a lifetime of safe, steadily-rising dividends.

— Dave Van Knapp