A:

When buying stock in a company, an investor becomes a part owner of that company. In addition to possessing the small degree of voting power that comes with being a stockholder, an investor is entitled to a portion of the company's assets and earnings. However, this does not necessarily guarantee that an investor will make money without selling an appreciated stock.

Receiving a cash dividend is one of the few ways that an investor can receive a share of the company's earnings without liquidating his or her position. Keep in mind, however, that companies tend to issue dividends when they are mature and do not have many good growth opportunities in which to invest. Therefore, companies that are currently in a growth phase tend to reinvest most, if not all, of their earnings back into new projects, leaving investors with no way of taking cash out of their investments other than by selling their shares.

The interesting thing about companies that declare regular dividends is that it is generally very rare that these companies pay a reduced dividend or fail to issue one at all. A regular dividend seems to serve as an indicator for investors and pundits alike that everything is well. Because dividends are derived from earnings, it is usually of critical importance that there are enough earnings available to pay the anticipated dividend. On the other hand, if a company is experiencing financial trouble, such as declining sales revenues, the amount of earnings might not match the earlier predictions, leaving the company unable to issue its regular dividend. (To read more, see Is Your Dividend At Risk?)

In light of this, if an investor wants to reap dividends as a source of income, he or she should pick blue-chip stocks, such as Microsoft or Wal-Mart, which have already grown to a level where growth opportunities are limited but earnings are relatively stable, allowing them to pay regular dividends.

For further reading, see How Dividends Work For Investors and The Importance Of Dividends.

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