Companies that are listed on stock exchanges often pay dividends, which is a distribution of their profits to their shareholders.
Dividends are of course a really good thing to receive as a shareholder of a certain company, but this is not always the best choice. There could be much better choices.
The management of a company has multiple different choices when their company earns profits:
- Reinvest back into the business;
- Repay their outstanding debts;
- Hold cash reserves in the bank;
- Buy back shares of their own company;
- Buy other companies to expand;
- Distribute dividends to their shareholders;
Sometimes it is a much better idea of the company’s management to reinvest profits back into their business to improve (and/or expand) their operations and future earnings. This will in turn improve the stock price and this could be more profitable for the shareholders than distributing dividends alone.
It is important to understand as an investor that receiving dividends is not always the best option. It is only the best option for the management to make if they believe that they cannot successfully reinvest the profits back into their business. Or any other of the options mentioned above.
As an investor, you should never look at dividends alone! You should always look at balance sheets and earnings. Earnings both in the past and in the future. Stock prices are all about company earnings. The most important things are steady earnings and profits!
Shareholders can earn money in two ways: capital gains by rising stock prices and profit distributions in the form of dividends.
There are certain companies that choose to never pay dividends to their shareholders. The major example is Berkshire Hathaway of Warren Buffett. They have never paid dividends but always reinvested profits back into their business or acquired additional businesses. Take a look at their amazing rise of over 24.000% in stock price over the long-term here.
Berkshire Hathaway is the ultimate example that dividends are not the most important thing for an investor!
If dividends are announced by the board of directors, investors must own shares before this date to receive the dividend.
Companies have full control over their profits (not their earnings), and can choose what to do with their profits. They could pay no dividends, stable dividends or a stable percentage in dividends.
They could also buy choose to buy back shares of their own company if they have made decent profits. This is also a really positive happenings for shareholders of the company. And this could also be more profitable to shareholders than receiving dividends alone. Buying back shares of their own company results in a rising Price-to-Earnings ratio (P/E ratio) and a rising stock price.
Dividends can be distributed in cash and in shares. This is also completely up to the management.
Investors have the choice to do with their received dividends as they please, and they could reinvest their dividends to buy more shares of the company. This could lead to a significant increase in profits.
Dividends are a good way to receive passive income as an investor.
We highly recommend to read the following books on dividends:
- The Intelligent Investor by Benjamin Graham;
- Security Analysis by Benjamin Graham and David L. Dodd;
- The Warren Buffett Way by Robert G. Hagstrom;
- Money: Master The Game by Tony Robbins;
- Unshakeable by Tony Robbins;