Many investors equate dividends with retirement portfolios, and while dividend paying stocks are a core element of many retirees’ investments, dividends may help boost investors’ portfolios over the long term no matter their age.
But first, let’s discuss what dividends are. Simply put, dividends are a share of a company’s profits and retained earnings that the company chooses to pay its shareholders in lieu of reinvesting the capital back into the business. Dividends, which are not guaranteed, are typically paid in cash, but companies can also pay dividends in the form of additional stock, which increases an investor’s ownership interest.
Investors considering a more long-term strategy might see a benefit in reinvesting their cash dividends to buy more of the same stock. When you use your dividend to buy more shares, the resulting growth in the size of your investment will generally increase the dividend amount you will earn over time, with which you can buy even more shares, essentially compounding the growth of your investment and resulting dividend. While this strategy can be a great way to grow a nest egg over time, it can also put more of your capital at risk compared to receiving cash distributions. Formal programs of this nature offered by companies are referred to as dividend reinvestment plans (“DRIP”).
Here is some basic information you should know about dividends:
- Dividends are determined on a per share value to be equally paid out to all shareholders of the same share class. The Board of Directors of the company must approve the dividend.
- The Board of Directors decides how often dividends are paid out – monthly, quarterly or annually, or as a one-time, non-recurring special dividend. Modiv pays monthly dividends.
- Large, well-established companies may be more likely to pay dividends, while younger, rapidly expanding companies often use profits to reinvest into their business.
- It is important to remember that dividends aren’t guaranteed, even by companies that have a precedent of distributing regular dividends. Payments are made from earnings, which are unpredictable and can oscillate for any number of reasons and there is no guarantee that dividends will be paid.
- Legally, a real estate investment trust (“REIT”) must pay out 90% of its taxable income as dividends.
- A common misconception is that dividends are the same as interest, but they are not. Dividends are distinct from interest, whereas interest income is typically set to a fixed rate associated with a bond investment, dividend income can increase or decrease over time and the underlying stock investment can too.
Dividend Rate or Yield
Another concept to understand when it comes to dividends is the dividend rate or yield. It is a financial ratio that expresses as a percentage the size of the dividend a company pays out in a year relative to its share price or its per share net asset value (“NAV”). The dividend rate is calculated by dividing the annual dividend per share by the share price or NAV.
One question investors often ask is, “Should I be worried if the dividend rate of my investment decreases?”
Not necessarily! While it may seem logical to look for companies with dividend rates that have increased over time, it’s important to understand the relationship of the dividend rate to price – a rising dividend rate may mean that the share price has fallen, not necessarily that the dividend has increased. Assuming the dividend amount stays the same, when the NAV/share price goes up, the rate goes down. While the dividend rate may be lower, the value of your overall investment has increased, and you would still receive the same dividend per share. In the example below, you can see how the dividend rate changes with an increase or decrease in the share price while the dividend per share remains the same.
Using the example above, if you owned 10 shares, the total annual dividend received would be $11.00 regardless of the share price and annualized dividend yield.
Not all dividends are created equal. Here’s how Modiv approaches its monthly dividends:
- Modiv intends to pay a dividend to investors on a monthly basis.
- Modiv calculates the dividend that can be paid based on adjusted funds from operations (“AFFO”), which is a financial measure used to estimate the residual cash flow of a REIT after accounting for rent increases and any routine maintenance that might be required to maintain the existing portfolio of properties. This method is a standard best practice adopted by many REITs. Because the AFFO reported in Modiv’s quarterly reports does not include capital expenditures, Modiv evaluates the coverage ratio to determine if it is adequate to also cover capital expenditures.
- There is no pre-established dividend rate; rather, the dividend is determined by the Board of Directors on a regular basis, based on a review of the company’s financial condition.
- One financial measure that is central to Modiv’s dividend policy is the dividend coverage ratio, or distributions as a percentage of AFFO, which provides an assessment of the portfolio’s ability to maintain the current dividend rate into the future. Modiv targets a dividend coverage ratio of at least 105%, which ensures that the portfolio’s earnings can sustain some limited weakness or volatility without necessarily needing to skip or reduce a dividend. Modiv’s target coverage ratio will be greater than 105% when it expects to require funds for capital expenditures. This fiscally conservative approach provides some margin of downside protection.
- The dividend is at the discretion of management and can be changed or eliminated at any time. Past performance is not a guarantee of future results.
To Wrap Up
Dividend investing (and reinvesting) may be a solid long-term strategy for those investors looking to build wealth and prepare for retirement. Keep in mind that investing in dividend-paying companies, including REITs, is not immune to risks, such as illiquidity and a complete loss of capital, and that payment of dividends is not guaranteed.
Modiv is not responsible for third-party content.
The views and opinions expressed in this commentary reflect Modiv Inc.’s (together with its affiliates, “Modiv”) beliefs and observations in commercial real estate as of the date of publication from sources believed by Modiv to be reliable and are subject to change. Modiv undertakes no responsibility to advise you of any changes in the views expressed herein. No representations are made as to the accuracy of such observations and assumptions and there can be no assurances that actual events will not differ materially from those assumed. The forward-looking statements in this paper are based on Modiv’s current expectations, estimates, forecasts and projections, and are not guarantees of future performance. Actual results may differ materially from those expressed in these forward-looking statements, and you should not place undue reliance on any such statements. These materials are provided for informational purposes only, and under no circumstances may any information contained herein be construed as investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any Modiv program or offering. Alternative investments, such as investments in real estate, can be highly illiquid, are speculative, may not be suitable for all investors, and there is no guarantee that distributions will be paid.