Some of the best stocks to buy are dividend paying stocks. These stocks will send you a monthly or quarterly check for your portion of their profits in the business. So you get a nice income stream from them. And the stocks can go up in value too. So you get the best of both worlds – investing and speculation.
But why would companies pay you dividends? Let’s look into that question.
Let’s say that you own shares of Hershey stock. And for the next three months, Hershey keeps making chocolate bars and selling them. At the end of three months, they figure out how much money they made selling chocolate bars.
They do this by taking the total amount of their sales, and then subtracting all of their expenses. The money left over is their profit for the past three months (the last quarter).
Now, Hershey can do a number of things with this profit money.
1. They can do nothing with it. They can just keep the cash and put it in the bank in their cash account.
2. Or they can invest some of it into creating a new chocolate bar, that might make their sales and profits even bigger in the future.
3. Or they can buy back some of their stock.
4. Or they can divide the profits up and send them to stockholders like you as dividend checks.
So how do these choices affect you?
Option 1 seems like it does nothing for you, but in fact, it does make your investment a little safer. With a bigger bank account balance, the company has more money for any emergencies that might come up.
However, if they already have a big enough cash balance, that’s not a very efficient use of profits. And there probably aren’t that many emergencies that come up in the chocolate bar business.
In option 2, where they invest in a new chocolate bar, that could increase profits in the future. So that might be a good choice, since your future dividend checks could go up – although you probably wouldn’t see any benefit right away.
However, in option 3, buying back some of their stock, might have a quick benefit to you. Because the value of you shares in the company could go up as soon as when they announced the buyback. Or right after they bought back the shares.
That’s because if the company bought back some of the stock, there is less stock available in the stock market. And usually, when there is less of something, the price goes up. So your shares would become more valuable.
Finally, in option 4, the company could just divide up the profits and send everyone a dividend check. They may decide they already have enough cash in the bank. And they don’t need any more products at the moment. And they don’t want to buy back stock right now because the price is high – they only want to buy when the price is low. You know, that buy low, sell high thing.
So since they have no other productive uses for the cash profits, they just decide to just send it to the owners – like you. Besides, they know the owners like their stock, and probably invested in it, because it pays dividends. So by constantly sending out dividends, they know people will keep investing in their stock. Which will keep the stock price up.
So it’s a win-win situation.
Now in the real world, the company may do any number of the things we listed. They may deposit some of the cash. And buy back some stock. And also send out a dividend.
But if it is a good dividend paying company like Hershey, they will be very motivated to at least send out a dividend check. Good companies that pay dividends take great pride in consistently sending them out, year after year. It’s a reputation thing. And it shows the owners, stockholders like you and me, that the company is well managed and profitable.
So that’s why companies pay dividends. And that’s why we buy their stocks. Because they pay us, the owners, our part of the profits – the dividends.
To your health and prosperity – John