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Dividends are essentially loyalty rewards for shareholders. Companies that issue them are paying out a small portion of profits to investors. They can pay out quarterly, monthly, or annually and come in the form of cash or additional shares. Either way, the more company stock you hold, the more your dividend earnings will be.
The majority of traded companies don’t pay dividends. First and foremost, the company has to be profitable. And smaller, newer companies tend to need their profits for research, development and expansion. Dividends then are a mark of large, established companies. These companies issue dividends because it makes their stock more attractive and incentivizes investors to hold and not sell.
As an investor, buying stocks with dividends has major benefits. It can provide a stable passive income stream. And for savvier investors, dividends can act as a hedge against market downturns. Research shows that dividends tend to rise when inflation is high. And during bear markets when stocks are falling, dividends help offset losses.
In the 2000s, when S&P 500 stocks fell amid the global financial crisis, dividends helped pare investor losses. In fact dividends have contributed a whopping 40 percent of the total return for the S&P 500 since 1930.
From a shariah compliance perspective, there isn’t anything inherently problematic about dividends. Afterall, they’re a portion of profit, not an interest payment. What matters is the underlying company and its activities.
As with all shariah-compliant investing, the company cannot engage in prohibited areas like alcohol and pork, gambling, weapons and interest-bearing financial products. You can vet the company’s activities or use an online stock screener like Musaffa, Islamically or Zoya.
Some indices track halal dividend stocks in particular, like the S&P High Yield Dividend Aristocrats Shariah Index. If you’re looking for investment ideas that include dividends, that could be a good place to start.
For more on sharia-compliant investing, see our guide on halal ETF investing
Firms that pay dividends usually also look to raise them. Those that manage to increase dividends consistently earn a positive reputation in the market. So-called Dividend Aristocrats are S&P 500 firms that have hiked their dividends for at least 25 years consecutively. An even more exclusive club, Dividend Kings, are companies that have raised dividends for at least 50 years. Companies like General Mills and Exxon Mobil have managed to pay dividends without pause for more than 100 years.
Conversely, if a company is consistently cutting its dividend this could be a sign of trouble down the road. During certain periods however, like during the outbreak of Covid, it’s normal for companies to cut back dividends to retain cash.
The dividend yield is a key metric to evaluate how much you will earn by holding the stock.
It is simply the value of the annual dividend payment divided by the current stock price.
Consider the following example:
● Say you own 200 shares of Company HLAL
● The current stock price for HLAL is $10
● HLAL pays an annual dividend of $0.50 per share
● The dividend yield then is: $0.50/$10= 0.05
● Your earnings would be: 200 x$0.50 = $100
The dividend yield lets you quickly eyeball the productivity of your investment and lets you compare stocks. Note that the dividend yield moves inversely with the stock price. In other words, if the stock price goes up, your dividend yield goes down. A dividend yield of 2-6 percent is considered healthy, whereas much higher than that could be a red flag for an unsustainable company.
Read more about: Accessing Yeild, Cash-on-cash & IRR
The other important metric is the dividend payout ratio. This tells us how much of the profits is being paid out to investors in the form of dividends versus what is being reinvested. It’s calculated as the total amount of dividends divided by the company’s net profit.
Take another example with Company HLAL:
● HLAL has net profit of $100,000
● It pays $30,000 in dividends to investors
● Its dividend payout ratio: 30,000/ 100,000 = 30 percent
A payout ratio of between 35 percent to 55 percent is considered healthy. But every firm has different factors, so each company should be evaluated on its own. Naturally if a company is paying nearly 100 percent of its profits in dividends, this is probably not sustainable.
This depends on where you live and whether you hold your investment in a tax-advantaged account. Some countries allow a certain level of dividends to be tax-free. And many stock dividends do get taxed at lower rates. These are usually called “qualified dividends” and can help you avoid paying for them as ordinary income in a higher income bracket.
Know more about: Tax Efficient Investments
Refrences
Inflation impact on dividend distributions
S&P High Yield Dividend Aristocrats Shariah Index.
S&P 500 Dividend Aristocrats
Divedends Kings in 2024
15 Companies That Have Paid Dividends For More Than 100 Years
What is the ideal payout ratio?
How are dividends taxed?
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
