What Are Dividends?

There are two main ways people can make money from owning shares in a company: when the company’s value and share price increases over time, and through dividends which can contribute to a passive income stream.

What Are Dividends?

Dividends are when a company distributes a portion of its profits, in order to attract and reward shareholders. If you own shares of a company that chooses to pay dividends, you’ll receive a slice of the profits based on the number of shares you hold—paid in cash or in the form of extra or discounted shares.

It’s up to each company to decide whether it will pay dividends, how much profit to distribute, and how often. It could be monthly, quarterly, annually or a sporadic ‘special’ payment. Publicly traded companies listed on the Australian Securities Exchange (ASX) that offer dividends tend to pay twice a year, following full and half-year earnings announcements.

How much do you get paid?

The more shares you hold, the higher your cut. The amount you’ll receive is expressed as a value per share, such as 30 cents per share. The amount per share varies significantly depending on the company and its profitability.

Do dividends affect your tax?

Yes, dividends count as taxable income. However, there may also be tax credits available if you receive fully franked or partially franked dividends from a company—which means the company has paid all or some of the tax already and you can offset this against your personal income tax.

What is dividend yield?

Dividend yield is a ratio that helps you understand the potential return for every dollar you invest in a stock. Dividend yield is expressed as a percentage, and is calculated by taking the annual value of a company’s dividends (per share) and dividing that by its current share price.

High yields are good, but once yields start exceeding 10% it may be an indicator the stock is volatile and riskier. Let’s say a company pays annual dividends per share of $2, and its share price is $20: the dividend yield would be 10%. If the share price halves, the yield jumps to 20%—but such a dramatic drop in share value could indicate a big problem with the company, and may mean future dividends are unsustainable.

Here are some key steps that will occur when a company decides to pay dividends:

• The company’s senior leaders and board will determine how much profit to distribute and approve a dividend payment.
• The company will announce their intention to pay a dividend and the value per share or other options such as when dividends are offered in shares, also referred to as a dividend reinvestment plan (DRP).
• An ex-dividend date will be set—this is the date by which shares must be purchased in order to be entitled to the dividend.
• Companies will also set a date for when the dividend will be paid, often around a month after the ex-dividend date.

Why do Companies Pay Dividends?

Some companies commit to consistent dividend payouts because they know many investors are strongly influenced by the ability to earn an income from shares, and attracting more investors and keeping current investors happy is good for the company. When dividends are offered in the format of discounted shares, it encourages shareholders to keep investing more in the company.

Market sentiment can be influenced by dividends. A company can’t pay dividends regularly unless it’s established and has stable earnings. Companies that pay dividends position themselves as financially strong, which may lift demand for its stock and increase its price.

Companies that Don’t Pay Dividends

Younger companies and companies that are growing rapidly may be less likely to be profitable, and also more likely to be focused on reinvesting any profits into expansion, product development or research initiatives.

Mature companies with considerable profits will have different operational and financial management approaches that determine how they use earnings, which may lead to a decision not to pay dividends.

One of the world’s most profitable companies—tech giant Google—has never paid investors a dividend. Reinvesting profits into the company may be seen as a preferable strategy for boosting a company’s share price by signalling its long-term viability.

Related: How to Buy Google Shares in Australia

To explore dividend investing, you might start by researching the publicly listed companies that have previously paid dividends.

Share trading platforms may have content or search tools that help you identify stocks that typically offer dividends and their yield ratios. You can also explore individual companies’ investor relations information and annual reports online. The ASX has a Dividend search tool you can use to explore past and current dividend announcements.

To be eligible to receive dividends, you can invest directly in individual shares, via exchange-traded funds (ETFs), or choose a managed fund that focuses on assets with the potential to deliver dividends.

Managed funds are managed for you, which may mean higher fees and conditions around minimum investment amounts and withdrawal options. Your money is pooled with the money of other investors and overseen by a professional fund manager who selects investments in a diversified mix of assets. You would need to choose a fund that focuses on investing in stock with the potential to deliver dividends.

ETFs are another pooled investment security that can help you diversify your investments, but they’re traded on the stock exchange like shares. Depending on the stocks included in a particular ETF, you may gain access to dividends.

If you’re using share trading platforms to self-manage your portfolio you can easily purchase individual shares in companies that pay dividends. However, it may be more costly to buy multiple stocks in an effort to diversify, and keeping track of multiple stocks can be time-consuming.

Related: How to Build Wealth in Australia

Investing in shares is generally viewed as a good long-term investment. So, it makes sense that buying stock in established, profitable companies capable of paying dividends could add stability to a portfolio as well as the potential for income. Investing in emerging, high-growth companies with a lower dividend yield ratio could also be value-for-money if the stock price rises.

Some investors prefer stocks without dividends, for a few common reasons:

• They don’t want to deal with taxation complexity related to dividend payments.
• They’re focused on long-term capital appreciation (rise in share value) rather than earning an income from their investment.
• They think lifting a company’s share price is better achieved by reinvesting profits in ways that increase the company’s value.

The Risks of Dividends

The main risk is that there are no guaranteed dividends and they can be reduced or discontinued entirely as a company’s fortunes or priorities change. Companies can and do adjust their approach to dividends when it becomes strategically important for them to use profits in another way or when profits are waning.

This, of course, speaks to the broader risks of any investment in the stock market—economic conditions change, markets can be volatile, and companies can flounder. Having a strong understanding of why you’re making certain investments, getting professional advice, and diversifying your portfolio can help mitigate risks.