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4 Rules to Consider Before Investing in Dividend Paying Stocks

4 Rules to Consider Before Investing in Dividend Paying Stocks

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Published by: Susan on Apr 28, 2013
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Dividends: Take the Money and Run
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In investing, there are precious few universal truths. One of them is thatcompanies that consistently pay dividends are good investments.There is no more reliable way to get consistent returns on yourinvestment dollars than using a well-thought-out long-term dividendstrategy.Dividendsare a portion of a company's earnings for the quarteror the year that is distributed to shareholders.
Read more:The 10 Largest Fiscal Cliff Dividend Tax Winners
The benefits of dividends are well documented. Studies show that about40 percent of the stock market's total returns since 1930 have come fromdividends. Also, buying dividend-paying stocks tends to provide a cushionagainst volatility (ups and downs in the market). A dividend strategy is a slow but steady way to win the long-terminvesting race — a race in which many non-dividend-paying companieslag behind or fail to finish.
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Too many investors, focused on the more speculative returns from shareprice appreciation, overlook returns from dividends, which are virtually assured each year by companies with long dividend-paying records.Dividends are a key part of what investment analysts calltotal investmentreturn– the money you ultimately make on your portfolio by differentmeasures. Whether a company pays dividends for a given period is up to thediscretion of the board of directors. Stocks that consistently pay dividendstend to be those of mature companies that don't necessarily need to retainearnings to pay for additional plants, equipment and people.The great thing about dividends is that they are cash in your pocket, and you can decide what to do with it, as opposed to letting boards of directorsuse the money to pay outsize bonuses to CEOs. Further, even highly successful, mature companies sometimes get lured into mergers andacquisitions that may not work out. So instead of reinvesting dividends,it's a good idea to just take the cash and keep it. This way, if badmanagement decisions cause the stock price to fall, your total returndoesn't take as big a hit.Dividends allow investors to get cash out of the market without sellingstock and incurring nettlesome trading costs. This is particularly attractive during retirement, when seniors want to hold on to their stocksso they don't outlive their assets. When comparing dividend payers with non-payers, consider companies'potential uses of their earnings:1) Buying back shares from investors. Buybacks can be beneficial toshareholders, but their effects aren't immediately clear. Dividendsamount to certainty.2) Investing in expansion, including the purchase of other companies. Theproblem with this is that even great companies sometimes makeregrettable decisions. For example, Microsoft bought Expedia, only to sellit at a loss.3) Holding on to a lot of cash, à la Apple, which has done so for decades.The company didn't announce its first dividend until March 2012.4) Distributing cash from earnings by paying dividends to shareholders.Bingo.Of course, just because a company is paying dividends, this doesn't meanthat you should necessarily invest in it. Here are some rules of the roadfor evaluating dividend payers:• Seek dividends; don't chase them. Sometimes companies declaredividends just to get more investors now and boost share price in theshort run. But down the road, investors drawn in by this may regret buying because the market punishes companies for decreasing dividendsor paying them inconsistently. When companies pay a lower dividend or skip a year, this can affect thestock's value. So investigate whether the company can afford to continuepaying dividends. Is the company amply covering its dividends withprofits? What is its growth rate? Is this rate rapid enough now, and based
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