Episode #11 - Time for a dividend
How dividends pay out outside of Monopoly
Intro:
For most, a dividend means a portly man with a mustache leaning back in a chair smoking a cigar guaranteeing your $50.
Hopefully after today’s letter, this grainy photo from Monopoly will be a blur and you’ll know exactly what a dividend paying stock is and how it relates to your financial health.
Passive investing, an often touched on topic in these letters, helps many people maximize value in the market. In an off-hand comment from one of my Torah teachers many years ago, he made the point that it isn’t particularly “Jewish” to enable your money to make money. In an act of defiance, I’m going to take some time in this episode to give an overview on dividends - yes, when your money makes money.
What are dividends? As I’ll review in this episode, they're a cash payout you get for owning a certain number of shares of a stock. The money doesn’t appear out of nowhere, it is from the company’s earnings and the amount is decided by the company’s board of directors. While not every stock has them, if you do have stocks with a dividend, you can earn money (subject to taxes) based on the number of shares you own. The dividend is distributed at a few different intervals including: quarterly, semi-annually, annually, or “irregularly” - why irregular will not be covered in this episode.
Please read until the end for the follow-up on last week’s note with a comment for extra research from Israel based VC, Michael Eisenberg of Aleph in light of the IPO of Lemonade (one of their portfolio companies).
Background:
If you’ve been following the last few weeks, the reappearance of the Dutch East India Co. will not surprise you and hopefully not fatigue you either. Yes, they were the first to offer a dividend to their shareholders. In terms of top-line Wikipedia history, the Co. actually paid a dividend of 18% for TWO-HUNDRED YEARS.
Essentially companies can only pay a dividend once they earn a profit (though in exceptional cases they’ll pay one when they don’t earn a profit). As you’ll recall from previous episodes, not all companies are actually net positive before they go onto the market, and even when they’re on the market, their value might often be tied to future earning potential not what they earned that day/month/year. Therefore, when a company offers a dividend it implies two things: a) they are earning revenue and b) they are earning revenue that they want to distribute to shareholders instead of reinvesting into the company.
The other nuance that will come up in the next section is that a company keeps investors abreast of their growth through dividends when a high-flying stock price no longer exists for the company.
A bit more in-depth
If you’re saying, “so companies that are failing offer dividends, right?” First, probably not and you should take another sip of your Monday morning coffee. Secondly, it is more nuanced than that take. Even though a company’s share price isn’t going through the roof, it could still be turning a steady profit. The way that a company can telegraph to its shareholders that things are going well without relying on accountants to prove that they are growing on each earnings call comes by way of the dividend.
If I can see dollars dropping into my account on a quarterly basis from a company that I own, I know that it makes money. Without that direct information, there are possible alternative explanations for a stock’s increase in value.
For a fun throwback, some ETFs and mutual funds also pay a dividend!
Our friends at Investopedia do share that there are some sectors that are more likely to pay a dividend - it usually coincides with industries that are more predictable:
Basic materials
Oil and gas
Banks and financial
Healthcare and pharmaceuticals
Utilities
Additionally, Real Estate Investment Trusts (REITs, for another episode) pay out a dividend because it’s part of their designation as a REIT.
Dividend payment gives the investor more options of what to do with their money, but it also makes you take some pause to better understand the company you’re invested in. I’ll share two questions: 1) What is the money NOT going to because it’s going into your pocket? 2) What will you do with the money now that it’s in your pocket?
Takeaway:
It’s likely that if you start getting into the market some of your investments will have dividends. You should pay attention to them. Are they reinvested in the stock (i.e. buying you more shares than you already have)? Are they paid out in cash that you get deposited directly into your bank account? Are you receiving the dividend as a check???
No matter how you’re getting your payouts, it’s important to keep in mind what is happening to the earnings you’re gaining each quarter (or whenever they pay out). Additionally, consider the tax implications based on your country/state and how a dividend might be a better way to receive income than to sell shares of your stocks in a more traditional “capital gain.” Each of these questions must be addressed as you grow your portfolio to include different types of investments.
Interact:
Do you have a portfolio? What investments pay you a dividend? How often does it pay out? How much does it pay out? What are you doing with those earnings?
Each of these questions should take you a few minutes to answer and when you decide your answer or as you contemplate your response, please respond here for the Winnings community to know too!
Gratitude:
I want to thank reader Menachem B for sharing Episode #10 with Michael Eisenberg. Michael responded with two points for further pondering and helpful context. Firstly, he mentioned that investors rarely can monetize on IPO, specifically as a function of a “lockup period” after the company goes public. While Michael did not share anything about his particular case, some research shows that 90-180 days after IPO is the typical lockup period when it comes to investors in stocks. The same type of rules apply to team members at a company who receive stock options as an incentive to work at what might be a lower compensation rate.
The second item Michael shared about Lemonade in particular was it’s status as a B-Corp. This status helps realign incentives in decision making and plays a part into better understanding Lemonade as a company. Perhaps in a future episode we’ll review this topic in greater depth.
As always, please send in questions or comments and share this work far and wide so we keep growing our Winnings family.