Editor's note: Welcome to "Booyah Breakdown," an explanation of certain terms and topics Jim Cramer discusses on his "Mad Money" TV show. Feel free to ask a question if you're confused about something Cramer talks about, but please keep in mind that we do not provide advice on specific stocks.
Jim Cramer likes stocks with dividends.
He was thrilled on Wednesday about
big dividend increase, along with its futureearnings potential. And on Thursday's "Mad Money" episode, he raved about commodities company
, which paid out a $1.50 "special dividend" this past year.
There's a good reason Cramer gets so fired up over dividends. As a shareholder -- essentially, an owner-- of a company, dividends are your cut of the pie. And you deserve your cut.
But merely giving out a dividend isn't enough grounds to jump on the stock's bandwagon -- especially if the company has to borrow money to pay it. And on the flipside, just because a company doesn't pay one, doesn't mean you should eschew it.
So do some dividend digging.
The Derivation of Dividends
Dividends are generally paid on a quarterly basis. They can be raised, cut or eliminated at any time, although once your company gets on the dividend bandwagon, it's very hard to get off. The shareholders and market won't be pleased.
A company's board of directors makes the dividend call. In an ideal world, a company's business makes tons of money, pays its bills and has cash left over. That extra cash is the company's retained earnings. The board members get to decide how that extra cash is allocated.
Back in the go-go days of the tech boom, there wasn't much money to allocate. Many companies didn't have any cash (or earnings or future potential) to distribute a dividend. But shareholders didn't really care because stock prices were flying. So a measly 2% dividend was irrelevant.
And the companies that did have cash were keeping it and reinvesting it back into thebusiness. That's was
rationale for holding on to all its money, reminds John Graham, finance professor at Duke University's Fuqua School of Business.
To watch Tracy Byrnes' video take of this column, click here
After the tech bubble burst, rocketing growth levels disappeared, the tax on dividendsfell to 15%, and companies realized they needed to start paying attention to their shareholders. So, dividends became important again. Microsoft jumped on the bandwagon and declared its first dividend in January 2003.
These days, many companies have more cash on hand than they've had in a while, and there'sonly a few things they can do with it: Pay down debt, buy back shares, make acquisitions or givesome of it back to shareholders.
"We think the best use of
cash is to pay a dividend," says Rick Helm, portfolio manager for the
Cohen & Steers Dividend Value fund. "It sends a clear message that the company has confidence going forward, and it's not afraid to reward shareholders for investing in it."
And Helm believes the dividend future is very bright. He's expecting companies on average will post annual dividend growth of 11% to 12% in 2006.
Now on to your digging.
Pull out your company's
Form 10-Q and read the section called "Management's Discussion and Analysis." Companies that offer dividends are pretty proud of their payout, so you'll probably find some mention of it here.
Next, flip to the cash-flow statement. The company has to have cash before it can distribute it to you. So, be sure you see positive numbers in the operating section, preferably with an increase over the last few years.
For tracking purposes, the financing section of the cash-flow statement is where you'll see your dividend coming out of the company. The "cash dividends paid" line will have a negative number.
Then flip to the
balance sheet -- a great place for dividend info. One of the line items is "retained earnings." That's basically a holding ground for the company's unspent net income. It's where your company gets the cash to pay the dividend.
When the company makes a dividend distribution, the retained-earnings account decreases. If yours made a distribution, you should see a drop in the retained earnings number. And while a decrease is to be expected, a negative retained-earnings account can be a bad sign. Again, make sure this account has a positive number and has been growing over the years.
Finally, pay attention to the long-term debt number on the balance sheet. Is it increasing? If the company owes too much, the dividend might be the thing to go if they have bills to pay.
Run Some Ratios
Now flip to the
income statement, and you'll see the actual "dividends paid to shareholders" number.
And here's where we do a little math. Or you can log on to a site such as Yahoo! Finance, put in your company's ticker and click on the "key statistics" section.
First, look at the dividend-payout ratio. It's just the dividend per share divided by earnings pershare. It basically tells you what percentage of earnings are coming back to you.
So, if you got a $1 dividend and EPS is $3, the payout ratio is be 33%. That means you'regetting 33% of the good stuff. Not bad. Of course, this ratio means nothing in isolation, so compare it to the company's peers.
Then move on to the dividend yield, which is just the annual dividend per share divided by thestock's price. It essentially gives you the return on your investment. Consider comparing thatyield to a fixed-income product like Treasury bonds, says Graham. Many dividend yields are actually higher than Treasuries these days. And that's probably why some folks swear by this ratio and will only invest in acompany that offers a high yield.
But not only do you need to compare this number to peers, you need to be skeptical of the ratio. Remember, if the stock price falls, the yield will increase. That's what has happened to all the big pharmaceutical companies, reminds Helm. So, understand the industry.
Cramer has warned that you need to ensure that the stock can support the dividend. Forinstance, he has noted that
can cover its 4.6% dividend yield and that
solid dividend yield of 2.4% supports the stock.
Basically, he wants to know that earnings are bigger than the dividend. If earnings are only 80 cents a share and the company pays out $1 dividend, where's it going to get the remaining 20 cents? At this point, it can't cover the dividend, and that's not good news.
More Dividend Details
Now that you know how fabulous dividends are, you need to know how to get them. Well, as theysay, you've got to be in it to win it. So be sure you get in before the "ex-dividend date."
When a company announces an upcoming dividend payout (i.e. the declaration date), it'll also announce the ex-div date. From the ex-div date forward, the stock trades as if the dividend was distributed. So, you need to own the stock before this day.
The record date is the actual day the company looks at who's on its books and starts cutting checks. So, if your name is in its rolls, you'll get a check.
Now keep in mind, you don't have to keep those checks. You could enroll in the company's dividend reinvestment plan (a.k.a. DRIPs) and just buy new shares with those dividend checks. Even better, most DRIPs will allow you to buy shares commission-free and at a decent discount to the current share price.
You asked Booyah Breakdown for more info on dividends, so I delivered. Keep the
questions coming. But for now, my brain is fried, and I'd like my dividend in a chilled martini glass.
Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University. Byrnes appreciates your feedback;
to send her an email.