If you are reading this post you have heard them before.
Those stocks that pay you a dividend quarterly in exchange for being a shareholder.
Those stocks that pay you to wait.
I mean hell, there are some hedge funds and mutual funds that are only allowed to buy a stock if it pays a dividend.
While dividends are nice in theory, they may not always be what they are so cracked up to be.
And like most things in financial markets, we have our own little twist to buying dividend stocks and how we look at them.
What are Dividends? They Are Nothing More Than Dividend Per Share!
Before we get into numbers here, as that is what we do, I’d like to spend some time on a little rant.
Companies that are growing and innovating who make money have an option. Let’s say Yelp makes 1 billion dollars this year. The following year they have a choice as to how they would like to provide shareholder value with that excess 1 billion dollars. Companies that are growing a majority of the time take that money and reinvest in their products, people, and services as they believe they are doing such a great job that they can leverage what they have been doing by applying capital and provide shareholder value that way. For the majority of companies that are in growth mode, this is how they spend their excess capital. Grow, grow, grow.
Other companies who are not in growth mode feel like they might not be able to provide shareholder value by actually growing the company. These companies typically have two options:
- Buy back stock and reduce shares outstanding to increase earnings per share
- Pay a dividend
These companies need a way to keep shareholders interested in holding/buying stock and they feel like they cannot use excess capital to become a better company, so they provide shareholder value by simply paying you to do it.
In my book, these companies are dead and are no longer growth companies. They know more about the prospects of their future earnings than anyone else and they are actively choosing to not invest in themselves. Yuck.
For the remainder of this post, we are going to use Apple as an example.
Right now if we went out and purchased 1 share of Apple stock, we would be entitled to a quarterly dividend that would total $2.28 for the year. This is what people feel is very valuable as they see it as getting paid to wait and hold the stock. If the stock goes nowhere, they still collect $2.28 for the year in the form of a dividend.
For starters, the problem most people have with understanding dividends is that they focus too much on the yield percentage. Right now, Apple is yielding 1.67% per year. A dividend is not a yield, it is nothing more than a dividend per share, which in Apple’s current case is $2.28 per share. When Apple was down at $100 a share its yield was 2.28% but its dividend per share was still and until they say differently $2.28.
What Happens When a Dividend Occurs
Dividends typically get paid out once a quarter or four times a year to shareholders. Let’s look at an example with Apple here.
Apple pays $2.28 a year so every four months, shareholders can expect a payment of $0.57. The day that this transaction happens is called x dividend. On x dividend day, Apple takes $0.57 per share and pays that out to its shareholders in the form of a dividend.
If Apple is trading at $125 the day before x dividend then the following morning $0.57 will be removed from every share. That means if it was supposed to open at $125, it actually opens at $124.43. Again, this is because, on x dividend, Apple pays out $0.57 a share.
While everyone is all hot about dividends, getting paid a dividend by the company is lowering the price of the stock as much as the dividend. Not everyone knows that and it is not the greatest news in the world.
What About Your Speech on Numbers?
Let’s look at it without rose colored glasses. If we buy 100 shares of Apple for $125 and hold it through four dividend payments, we will collect in dividend per share alone $2.28. That’s not bad. But we can one up that.
A covered call is selling one call against every 100 shares of stock. In the example above, we purchased 100 shares of Apple. Because we bought 100 shares we are able to sell one call to “cover” the position because one option contract for a stock is equivalent to 100 shares. When we sell a call we collect the value of the option in premium. In my eyes, this is not much different than collecting a dividend.
So here we are, we bought 100 shares of Apple for $125 and we also know we are collecting a dividend for $2.28. In order to collect that dividend let’s say we are going to hold the stock for one full year. If we sell a covered call one year out, we would collect the premium for the covered call as well as the dividend as we will be a shareholder for one years time.
We can sell the $140 call in Apple right now what expires about one year from now (enough time to collect four dividend payments) and the premium we will collect is $10.25 per share. Take that and add it to the $2.28 dividend per share that we collect for simply being a shareholder and what do we get? We get $10.25 + $2.28 = $12.53 collected for the year.
For discussion purposes, let’s call this a Super Dividend. We collect money in the form of a cash payment quarterly throughout the year for being a shareholder as well as collect the premium from selling the call at the money we sell it in the form of a cash payment. Not bad. I would love to have $12.53 per share deposited into my account in various cash payments in a years time.
While dividends are all a buzz, they aren’t the greatest thing since sliced bread. The company that you are a shareholder of no longer thinks they can grow their business by investing in themselves. Rather, they feel like the only way to make more money and keep you as a shareholder is to pay you.
On top of this dividends are not yield they are simple a dividend per share in the form of a cash payment quarterly.
While getting paid out by a company is great, if you are willing to collect a dividend why not look into selling a call against every 100 shares of stock you have? Collect as much money as possible. How could that not be something we do every single time?