Are you looking to know more about ASX share dividends with franking credits, like those offered by Commonwealth Bank of Australia (ASX: CBA)?
You've come to right place.
Dividends 101
It might sound a little obvious, but you shouldn't buy shares of companies that are not profitable. According to Section 254T of the Corporations Act (boring!), a company is not legally able to pay dividends if it does not have enough assets to cover its dividend payments or if it would hurt existing suppliers.
Basically, you want to buy shares in a quality company which is growing its profit at a healthy rate, so you can benefit from increased dividend payments over time.
Payout ratio
The payout ratio is calculated as dividends divided by profit. For example, Commonwealth Bank paid $4.29 in dividends this past year and made $5.56 in profits (per share). It has a payout ratio of 77% (4.29 / 5.56). You can use this formula to get an idea of how much profit is being paid back to shareholders and how much the company is using to reinvest back into the business for future growth. You can also compare the payout ratio with its peers.
Usually, lower equals better because a good company will have growth projects in which it can invest for high rates of return.
If it cannot invest for growth, like many mature businesses, its growth might be slowing down. That could mean lesser increases in dividends.
If the payout ratio is really low, it could mean that the company will have the ability to increase its dividends in future years.
Franking credits
In addition to a regular cash payment, some Australian companies can also pay something called franking credits along with their dividends. You can think of them as 'tax credits' paid by the company on its profits. When the dividends are paid to you, the franking credits can be attached.
Ultimately when companies, like Telstra Corporation Ltd (ASX: TLS) or National Australia Bank Ltd. (ASX: NAB), pay their dividends to shareholders the franking credits can boost their dividend income after tax.
Foolish Takeaway
Dividend investing is a very popular way to grow wealth in the Australian sharemarket since there are generous tax advantages and many companies have large payout ratios.
However, even if your focus is dividend income it is important to buy shares of growing companies to ensure that the investment will pay a cash return to you for many years into the future.
