There are a lot of reasons to buy stocks, but whether you buy because of a gut feeling, a low P/E ratio, or because of someone screaming with excitement about a stock on a cable news network, one of the factors to consider in an investment is always the dividend. Some stocks don’t pay a dividend and that doesn’t mean they aren’t worth an investment, but you’ll need to rely on that stock price to increase if you hope to earn a profit. Dividends are a distribution of corporate earnings back to shareholders. The total return on a stock is the change in the stock’s price plus the annual dividend distribution. There are 4 main reasons why dividends are attractive.

- Dividends Offer Tax-Advantaged Income: It’s almost impossible to generate income from your investments without the government demanding a cut, but dividends are taxed at a lower rate for most people compared to most other investment income. Dividends are taxed at a 15% rate for all investors, regardless of income. The tax code can change at anytime but for now, the income stream from dividends leaves more money in the investors pocket than interest income. Even more attractive, if you buy stocks in a qualified account, the income stream is not taxed at all.

- Dividends Are A Sign Of Strong Cash Flows: In a world where names like Enron are fresh in the minds of investors, there is still a feeling of distrust when it comes to corporate America. Accounting tricks can make an income statement look solid when the reality is that cash flows are weak. Dividends are a distribution of cash though, and that cannot be fabricated. You may feel more comfortable investing in a company that generates a real, tangible cash flow.

- Dividends Are A Buffer Against Loss: If you invest in a company with a 3% dividend and markets enter a narrow trading range, that 3% becomes an important part of your total return. If the stock price stays relatively flat, you’ll still have a positive return with a dividend paying stock that is quite a bit more attractive than interest rates on cash and fixed income investments in this market.

- Dividends Provide A Predictable income Stream: In an economy where there is almost nothing predictable anymore, dividends can become a reliable, steady element of your investment income. This is especially important for people who rely on their investments to generate income such as retirees. It’s important to realize that dividends are not guaranteed and companies can increase or decrease the amount they pay in dividends at anytime. However, there are a number of companies with a strong track record of not only paying dividends but increasing their dividends on a regular basis.

- Dividends Can Be Automatically Reinvested: Most online and full service brokerage firms allow investors to reinvest the dividends they receive in a stock without transaction costs. This allows investors to systematically increase their positions in good companies which will in turn enhance their income stream that comes from dividends. Remember that reinvested dividends are still taxed, so you’ll need to have funds available to cover your tax obligation.

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Tags: dividends, income stream, Stocks

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