by Janet Grischy

Created on: July 13, 2010

Dividend stocks are shares of companies that pay dividends, which are the investor's cut of the profits that companies earn. Dividends are distributed to the owners of the company, the shareholders, with each holder of common stock entitled to a payment proportionate to his or her ownership in the enterprise.

Some companies do not pay dividends, whether or not they make profits, and from an investor's point of view, they have rather different characteristics from stocks that do. Some companies that do not pay dividends are growing fast, and need all their capital. Others are in trouble, and really need their cash.

Still other corporations reward investors with stock buybacks rather than dividends. Stock buybacks can serve as the equivalent of dividends, but with far better financial consequences, or they can be an illusory way of seeming to reward outside investors.

Whether a stock that pays dividends is better for a given investor than a company that does not is a complicated question. The answer depends upon the investor’s personal circumstances, on the general characteristics of dividend paying stocks, and on the specific nature of a certain stock.

Reasons to buy dividend stocks

When an investor receives a dividend, he or she receives actual cash that cannot be lost in the market or the economy. When companies retain money that could be used to pay a dividend, they may or may not do well with it. The investor may receive more money down the road because the company has done well with the money they have kept. On the other hand, the company may fritter the money away (it happens), or lose it in a prolonged downturn or sudden disaster. A dividend payment eliminates some of a stockholder's uncertainty. Actual cash is a sure thing.

For this reason, among others, when the market declines stocks that pay safe dividends are more likely to retain their value, or to recover it if they do decline. Down markets are frightening, and the certainty of a dividend takes away some of the fear.

As of 2010, dividends are treated relatively benignly by the U.S. tax code. They are actually taxed at a lower rate than money a taxpayer earns, if he or she retains dividend stocks for a reasonable period.

This policy actually encourages investors to buy and hold dividend stocks, a sane and reasoned investment policy for investors with many other things on their minds than watching the market.

However, tax codes to do change. As it stands, the government will tax dividends earned

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