Dividend Paying Stocks – Good Idea?

Different investors vary on whether you should invest in dividend paying companies.

Hint: Warren Buffet is NOT a big fan.

Ways for Companies to Handle Profits – What are dividends?

Before we decide whether investing in dividend paying stocks is a good idea, it might be a good idea to explain what dividends really are.

Most companies are trying to make a profit. When they do, then they have another question to answer:

What should they do with that newly generated (extra) money?

They can either retain their profits within the company, or they can pay out those as dividends to its stockholders.

Why would a company pay me a dividend if it is not required?

A company will pay a profit for several reasons:

• Investors are more likely to keep their investment IN the company instead of selling it.


• It makes the stock more attractive, which often drives UP the price of the stock. How does this benefit the company, if it wants to sell more shares of stock in its company, then a higher price allows them to raise more capital for themselves while selling off a smaller portion of their company.


• It creates positive press about their company. Any time a company pays out dividends, most people will view the company as being in good health, making it easier to raise funds later, if they need.

If the company does not pay me dividends, what is it doing with that money?

With the profit the business generates, the company can pay out dividends to its stockholders (part owners), but it does not HAVE to pay out dividends in most cases.

Here are other ways the company can spend its profit money:

• It can put that money in Research and Development, which allows it to develop new products or services.


• It can put that money in Marketing, which allows it to improve its position within its industry or do damage control, if necessary.


• It can repay some debt, reducing its long term and current liabilities. This can reduce its ongoing expenses, making it easier to generate more profit later. It also makes it easier to obtain funds at lower prices later.


• It can buy back some of its stock that it sold earlier. This is great for the company, because it controls a greater portion of its company. It’s also great for stockholders, because while the company selling shares dilutes the stock’s value, buying back shares improves the stock’s value, especially when reporting earnings per share.

Benefits of Dividends for the Stockholder

The benefits, at this point, might be straightforward:

• Cash Flow: Dividends produce cash flow in your pocket without having to give up equity (shares) of your stock.


• Stock Price: Dividend paying stocks provide something that other non-paying dividend paying do not…CASH. THAT increases the stock’s value, especially when the dividend AMOUNT increases.

This sounds great! Are there any downsides?

Dividend paying stocks can be a terrific thing. However, like most things in life, there are some tradeoffs.

You need to be careful of…

• When the dividends reduces or drops, often the stock does, too. Beware of any activity that could likely cause the company to change its dividend paying behavior negatively.


• It could be a smokescreen. When companies pay out of dividend from profits, this is very good. However, sometimes, it might be at the expense of cash flow, putting themselves in a vulnerable position. The company might be sitting on a big pile of cash, even if it is not profitable. When the company pays out dividends, many people assume all is well with the company. Take a note to see whether there could be future problems with its ability to pay its expense obligations or generate a profit later.

What do I recommend?

I recommend that you check each company thoroughly for what YOU want and is important to you.

Personally, I like dividend stocks where I am playing them, but I also know that they could be dangerous. I am always watching my investment to see if any changes are coming that I don’t like. If I see something, I recommend that I bail.

I also do not want to blind myself from a great opportunity from a growing company that is using all of its profits to continue funding its growth that its market demands. There could be some great gains to be had, even though they do not pay dividends. I don’t want to miss these, because I was only watching dividend paying stocks closely.

Final Recommendation: Dividends are a great part of your investment plan, but they should not be your only part of it.

Warren Buffet is right, also, though. If the company can use the funds to my benefit better than I can, I’m okay with them keeping my money. If not, I want them to pay me!