Stock Market Basics for Dividend Investing
The recession that began in late 2007 changed the dividend landscape completely, and not necessarily for the better. In the last quarter of 2009 alone there were 288 companies who cut their dividend payouts. In fact, Standard and Poor’s reported another 804 companies who were forced to follow suit in 2009. This cost investors another fifty-eight billion dollars.
There are four lessons you should learn before you get involved in dividend investing.
1. There are no guarantees
Many people decided to ignore this lesson in the years before the recession hit. While collecting interest on other investments, such as CDs and bonds, is something you can count on, the same is not true of dividends. The board of directors get to decide whether or not shareholders will be entitled to cash dividends. Most companies recognize that it is in their best interest to maintain or ideally increase payouts. Continuing to pay dividends is a good sign of a company’s financial health. A financially strong company can also attract more investors, enabling them to grow.
2. Do not go after high yields
In the last few years there were many investors that got too greedy and started taking higher and higher risks to find yields that were acceptable. This was possible because interest rates and market yields were very low. However, this turned out to be a bad decision in the long run. To minimize risk, investors should avoid any yield higher than 2.5 times market average. For example, the current market average is two percent, therefore you should stay away from anything five percent or more.
3. Cash flow is king
Do not just look at a company’s earnings this year, but also look carefully at the cash going out and coming in for the last five years, at least. If you focus just on earnings, you will not have a good picture of a dividend’s sustainability. Also try to account for capital expenditures as well. The remaining amount is called the free cash flow and is what the company has available to either pay dividends or buy back shares. Also check how much the company pays out in dividends every year. The free cash flow needs to be greater than the dividends paid so the company can maintain dividend payouts.
4. Don’t put your eggs in one basket – diversify
No matter what the current financial situation may be, diversifying your portfolio will help you weather even the toughest situations. Diversification is the basic rule in your building your portfolio and this is a lesson that should learnt in your stock market basics class. The financial industry was hurt worse than others over the last few years, and even those who diversified were hurt. However, they were also less affected than people who put all their money into high yield financial stocks. Diversifying is still important even if the yields are lower.
These four tips will ensure that you have a much easier time building your portfolio. You will be able to find companies that have a sustainable dividend payout with a higher than average yield.
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Stock Market Basics – Terms and Phrases
When you’re learning the stock market basics, you’ll hear terms and/or phrases being used that you might not be aware of or have no idea what the person is talking about. In this post we’ll go over some of the ones that you will hear almost everyday.
Points- There are several different ways that this word is used throughout the markets. A point is referred to as a way to measure. In regards to a stock gaining a point, it means that the value went up one dollar. When the news says that the federal reserve lowered the interest rate by 50 basis points, that would mean that the interest rate dropped by a half of a percent (0.5%).
Long/Short- You will hear traders say that they are either long or short a stock in their portfolio. What they mean by “long” is that they are invested in the stock for the purpose of it going up in value. When they refer to being “short” a stock. They are investing in the stock expecting it to go down in value. Yes, You can make money in stocks as the price per share drops (that’s something that you will learn later).
Bonds- A bond is actually a loan with a little more complicated terminology added to help keep the average investor from getting involved without the help of a professional. When the government or a company wants to raise capital (cash) for one reason or another, they issue bonds to individuals or other entities. The interest is paid to the lender on a yearly basis (annuities). The actual principal (money borrowed) is not paid back until the end of the terms stated in the bond.
Dividends Dividends are what a company pays to their shareholders in the form of cash or more shares of the company. Companies that have grown to their maximum and have no plans to acquire other companies pay dividends. The dividends are calculated on a percentage of what each stock is worth. The payment is broken down into four payments (each quarter). There is some other factors involved with dividends that I won’t get into in this post.
Diversified Portfolio- A portfolio that only contains stock from one sector will not do as good as one that contains stocks from several sectors. Stocks rise and fall all the time, but that doesn’t mean that they all go in the same direction or by the same amount together. If you balance your portfolio correctly, you will do quite well on a regular basis.
In later posts I’ll add some other term and phrases that will help you understand the stock market better.
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