Dividend investing involves the purchasing of dividend paying stocks. A dividend is a payout of profits by an entity, to its shareholders. It is a proportion of the profits which are not retained by the corporation, which are distributed among investors. It is not mandatory for a company to pay dividends, the board of directors makes this decision.
Not all companies pay a dividend, companies in the high growth stage of their businesses lifecycle generally choose to reinvest profits in order to maintain their expansion. More mature firms, with stable and consistent earnings are more likely to pay dividends. Dividends may not be an efficient method of investing due to the double taxation, paid by both the company and the individual shareholder.
It is important to take other factors into account when choosing stocks based off their dividend. Dividend yields can can change either by a change in the dividend amount or a change in the stock price of the company. A higher dividend yield might not necessarily mean a more attractive investment, as it could be due to a decreasing share price. Similarly, companies with high payout ratios – the proportion of earnings paid out to as dividend – could restrain future growth with a lack of retained earnings.