What are Dividends?
Overview
This module will take a look at what dividends are and the different ways in which companies pay these out.
As you invest in shares, it is important for you to understand how much you may get paid from these as well as whether the company has a good long-term strategy based on how they distribute their profits to shareholders (including you).
Receiving a dividend is one way of gaining an income from your share investment.
Defining Dividends
Dividends are how a company rewards or pays out a portion of its profits to shareholders/ investors. It is important to note that not all companies pay dividends, even if they are profitable. They can choose to do several things with the profit made such as:
- Re-invest it into their business
- Pay off debt
- Pay a portion of these profits to their shareholders (i.e. dividends)
It is the company board's discretion whether to pay out dividends to shareholders and how much to pay in dividends. For instance, if I invested R1000 at R10 each with 100 shares, it pays out 20c per dividend I would get R20.*
*Brokerage costs and taxes are not included in these examples
How Much Will I Get Paid?
If a dividend is declared, the amount you would receive depends on the number of shares you hold because all dividends are paid on a “per share basis”.
Remember, companies can choose the level to pay, which can be anything from, more than the years' profit, (as long as they have accumulated and retained previous years’ profit), or it could be nothing at all.
Dividend Pay-Out Ratio
This is the percentage of net income paid out in the form of dividends:
- Dividend pay-out ratio = (gross dividend payment)/(net income)
Despite the obvious desire to receive more of a payout in dividends, wise investors often prefer to see this ratio at a level less than 70% because then they know that earnings are going back into growing the business. Often when a company is in a development phase, dividend pay-out can drop all the way to zero in order to use available cash flow to fund projects. So don't automatically write off shares that pay no dividend income either.
Dividend Yield
The dividend yield is the percentage of net income to be paid out as cash dividends to shareholders.
- Dividend yield=(Annual dividends per share)/(Price per share)
The company decides on the dividend yield based upon its preferences, which are either to distribute income as cash dividends or to re-invest the income back into the company to generate further income.
As a shareholder who has purchased shares in a company, the dividend yield may be very important to you when considering purchasing a share. A high yield indicates that you will obtain a high revenue from the share.
A high dividend yield may not necessarily mean that your share value is made the most of, because companies that retain their earnings and pay low or no dividends may use those reserved earnings to grow and build the company and therefore grow your investment, which means you have a capital gain.
Obviously the ideal situation is to own a share that gives you both income and a good capital growth.
Important Dividend Dates
There are three important dates relating to dividends:
1) Date of declaration – this is the date on which the dividend is declared by the
company.
2) Last Day of Trade (LDT) – Only shareholders owning this share on this date will receive the dividends. You may sell the shares after this date and still receive the dividends.
3) Date of payment – This is the date of payment of the dividend. Dividends are
only paid to shareholders registered on the date of record.
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