Dividends & Capital Growth
Overview
As an investor in shares, you face a number of responsibilities and risks, but there are also some benefits that you receive.
The idea behind investing is that you can gain profit from the funds you have chosen to put in certain shares in the near or distant future. In order to profit from your investments, you need to be aware of the different ways this can happen.
This module will offer brief insight into two avenues of profit available to you as an investor, namely, dividends and capital growth.
Dividends
A dividend or a cash payout to share investors, isn’t just a source of income, it’s a sign of a company in good financial health.
Dividends are cash distributions that many companies pay out regularly from earnings to shareholders. They send a clear, powerful message about future prospects and performance.
The willingness and ability of a company to pay stable dividends over time – and its power to increase them – offer good clues about its fundamentals.
Usually, mature, profitable companies pay dividends. Nevertheless, if companies do not pay dividends it does not necessarily mean they are without profits. If a company believes that it offers healthier growth opportunities compared to investment opportunities available to shareholders elsewhere, it often holds back the profits and reinvests them into the business.
For these reasons, few "growth" companies pay dividends. However, even mature companies still need to hold back enough cash to fund business activity and handle unforeseen events, even if much of their profits may be distributed as dividends.
Dividend Yields
It is even better to pay attention to how the dividend yield has behaved over time. The dividend yield is a measure of how much income is received in proportion to the share price.
You calculate the dividend yield by dividing the dividend received over the last 12 months into the share price.
Dividend Yield= (Annual dividends per share)/(Price per share)
Shares with higher dividend yields tend to be more attractive to the income investor because they result in better rates of return.
If the dividend paid per share is increasing but the share price is falling, this may be a signal that the market doesn’t believe that the business will be able to maintain the higher dividends. An increasing dividend yield may be cause for concern.
However, if the dividend yield is rising along with a rising share price trend then this can be taken as a healthy sign.
Capital Growth
Capital growth, also known as capital appreciation, is a rise in the value of an asset or investment over time.
Capital growth is the difference between the current share value and its purchase price at the time it was bought.
Capital Growth = Current Share Value – Share Purchase Price
The degree of capital growth that's advantageous depends on the investor and the investment objectives. The investment objectives differ among investors, depending on their level of risk tolerance.
Investors with low-risk tolerance are likely to seek income, while investors with high-risk tolerance are likely to seek capital growth.
Capital gains are entirely different from return in that they are only realized when the share is sold for a price that is higher than the price at which it was originally purchased. (Selling at a lower price is described as a capital loss.)
Therefore, investors looking for capital gains are not likely to be those individuals who need a fixed, ongoing source of investment returns from their portfolio, but rather, those who seek the possibility of longer-term growth.
Capital growth is mostly realized through the purchase of ordinary shares, mainly growth shares, which offer low profits but great opportunity for increase in value.
For this reason, growth shares are considered to be some of the most speculative of investments as their return depends on what will happen in an unpredictable future.