Practical Guide: How to Generate Passive Income with Stock Dividends

If you aspire to grow your wealth sustainably through stock investments, there is a key element you cannot ignore: dividends. They are the rewards that companies give to their shareholders in recognition of investing in them. In this article, we will cover everything from fundamental concepts to advanced strategies to maximize your profitability.

What do dividends really hide?

Dividends are, essentially, the distribution of profits that a company makes among its shareholders. When a company earns profits, it decides what percentage to reinvest in its growth and what part to distribute among shareholders. This mechanism acts as a magnet to attract capital and investors seeking steady income.

It is important to highlight that each company sets its own policy: some prioritize aggressive growth (like tech companies) and allocate little or nothing to dividends, while others, with established businesses, distribute significant percentages of their earnings.

Dividends vs. Coupons: don’t confuse these terms

Many investors mix these concepts, which are substantially different. Dividends belong to the world of equity (stocks): shareholders perceive them as participation in profits, with no predefined maturity date. In contrast, coupons are periodic income from fixed income (bonds and debt securities): the investor acts as a creditor and receives predetermined payments until recovering their capital on a fixed date.

The comparison table is clear:

The dividend per share formula: the first step in calculation

Calculating dividends is simpler than it seems. The starting point is to determine the dividend per share (DPS), whose formula is:

DPS = Profits allocated to dividends ÷ Total number of shares outstanding

Knowing the DPS, you can derive the dividend yield (DY):

DY = (DPS ÷ Current share price) × 100

Practical calculation example

Let’s imagine Banco Dinero reports profits of 10 million euros and decides to distribute 80% (8 million) to shareholders. With 340 million shares outstanding:

• DPS = 8,000,000 ÷ 340,000,000 = 0.0235 €
• If the share trades at 1.50 €: DY = (0.0235 ÷ 1.50) × 100 = 1.56%

This is the annual return you would get from your investment in the form of dividends.

Essential terminology in the world of dividends

Dividend Yield (DY): The profitability expressed as a percentage that you will receive as a shareholder.

Payout: The percentage of earnings that the company allocates to dividend payments. Young “growth” companies keep it low; established ones approach 100%.

P/E Ratio (PER): The ratio between the share price and earnings per share. Indicates how many times the annual profit equals the current price.

Earnings per Share (EPS): Net profit divided by the total number of shares, showing the unit gain.

The different dividend models you need to know

There is no single type. Companies employ different formulas:

1. Ordinary or interim: Based on forecasted profits not yet finalized.

2. Final: Adjusted to confirmed profits at the end of the fiscal year.

3. Extraordinary: Originated by exceptional events (sale of assets, for example), not operational performance.

4. Flexible or script dividend: Allows shareholders to choose between cash, new shares, or a combination.

5. Fixed: The classic formula: remuneration in euros (or the base currency) approved according to results.

The ex-dividend date: the decisive factor in your operation

Here lies a critical aspect that many traders forget. The ex-dividend date is the dividing line that determines who receives and who does not. If you hold the shares until that date (even if you sell them the next day), you are entitled to the dividend. If you buy on or after that date, you lose that right in the current round.

This concept relates to two more dates: the record date (when it is confirmed who receives) and the payment date (when the payment is made).

Concrete example

Banco Santander announces a dividend of 0.80 € per share to be paid on April 8, with an ex-dividend date of April 6. Ramiro sells 300 shares to Pascual precisely on the 6th. When the payment arrives, Ramiro receives (he was the owner before the ex date), but Pascual receives nothing that month, even if he is the new shareholder.

Growth vs. Value: the central role of dividends

This is the boundary between two investing philosophies:

• Growth Stocks: Prioritize growth (technology, biotechnology), allocate income to expansion, and generally distribute low or no dividends.

• Value Stocks: Mature businesses with stable cash flows (utilities, energy, basic consumption) that distribute significant dividends.

Dividend Aristocrats: the elite of distribution

In the S&P 500, there is a selection of 65 companies called “Dividend Aristocrats” that have increased dividends year after year for more than 25 years. Names like Coca-Cola and Procter & Gamble have been on this podium for decades, as well as recent additions like Church & Dwight. This designation is synonymous with reliability and financial stability.

CFDs and dividends: a relationship you must understand

Even if you trade with Contracts for Difference instead of direct shares, CFDs also distribute dividends. As a derivative product, they replicate the behavior of the underlying asset, including its distribution policy. The only limitation is that you do not have voting rights in shareholder meetings, which is generally irrelevant for most retail investors.

Building a dividend portfolio: a proven strategy

A successful dividend strategy requires disciplined planning. Avoid seeking explosive gains; instead, focus on:

1. Companies with a consistent and growing history of dividend payments.

2. Defensive sectors: utilities, essential consumption, energy.

3. Attractive valuation: look for low PER within their sector, never comparing across different industries.

4. Reinvestment: leverage the power of compound interest by reinvesting received dividends.

5. Financial solidity: prefer companies with low debt so that rate hikes do not cut payments.

6. Constant monitoring: even with a buy & hold strategy, periodically review financial statements to detect changes.

Final reflection: dividends as an investing compass

Dividends are much more than additional income: they are an indicator of corporate health and stability. They directly influence the share price; positive news about dividends increase the stock’s value, while suspensions severely punish the quote. Even on the payment day itself, the stock typically drops by the amount of the distributed dividend.

Regardless of whether your strategy focuses on dividends or not, understanding them is fundamental. It is knowledge that every serious investor must master to operate wisely in the markets.