What is a Dividend?

Here we examine what a dividend is, why companies pay dividends, how dividends impact on share prices and the value of dividends to investors.

blockletters spelling dividends
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Dividends are paid out to shareholders from the profits a company makes. It’s essentially a way of rewarding them for investing in the business. As earnings are usually passed on to shareholders in the form of cash, dividends are often described as cash distributions.

Key takeaways:

  • Cash dividends are most common, but earnings can also be paid out as shares
  • The amount of dividends you’ll receive depends on the number of shares you own
  • Dividends often come with franking credits that can potentially lower your tax liability

Understanding dividends

So how do dividends work? Under Australian law, Board of Directors can authorise a dividend if they are satisfied that the company:

  • Has sufficient net assets
  • Can still pay creditors after dividend payment
  • Is paying a dividend that’s fair and reasonable

The Board will then need to decide when and how much dividend to pay.

Not everyone considers paying dividends as a smart move. Some investors believe reinvesting profits can increase a company’s long time value and deliver shareholder benefits through higher share price. However, others favour dividend payments because they want more certainty and to receive income sooner.

Another benefit of dividends is that they often come with franking credits. These tax credits can reduce a person’s assessable income and lower their tax bill. ¬†

You’ll often come across the term “dividend yield”. It’s a¬†useful metric¬†to quickly identify stocks that pay higher dividends, and is calculated by dividing a company’s annual dividend by its share price. ¬†

Dividend-paying companies

Growth companies are likely to have higher investment expenditures and less sources of finance, so they’ll tend to reinvest rather than distribute profits.

However, mature firms tend to have stable sources of finance, lower debt levels and repeated profits, so they can afford bigger dividends. 

Blue chip companies from mature industries like banking and financial services, resources, and retail are likely to offer higher distributions. 

Important dividend dates

You’ll need to pay attention to the following dates to ensure you qualify for the dividend:

  • Declaration date:¬†This is when the company announces a dividend to the market, including how much it’ll be and whether it’ll be a cash or shares distribution. It’ll also declare the ex-dividend date
  • Ex-dividend date:¬†You need to own the company’s shares on this date in order to receive the dividend announced¬†
  • Record date:¬†The date¬†after¬†the ex-dividend date. At 5pm on Record date, the company will close its share register to identify shareholders eligible for the dividend
  • Payment date:¬†This is when money or shares are paid out to shareholders.

Impact of dividends on share price

Leading up to the ex-dividend date, a company’s share price may rise as a result of higher demand due to investors buying shares to qualify for the distribution.¬†

On ex-dividend date, the share price of the company is likely to fall by the dividend amount. This is because investors who buy shares from this point onwards are ineligible for the distribution.

Why do companies pay dividends?

Companies are not obliged to pay dividends. However, shareholders expect a return for their investment, and companies can deliver this either through capital gains or dividends. 

Since only profitable companies can pay dividends, distributions signal financial strength and stability. This can bring in new investors and lift demand for a company’s shares. Hence, dividend-paying companies are often reluctant to reduce or stop paying dividends, as dividend cuts can give the impression of financial trouble and spook potential investors.

Of course, how dividends are paid are just as important as why they’re paid. While cash distributions are more common, companies sometimes pay share dividends instead.

There are no rules regarding how often dividends should be paid, but many Australian Stock Exchange companies pay an “interim” and a “final” dividend.

Fund dividends

While dividend definitions often focus on distributions directly made to shareholders, a mutual fund will also pass on dividends it receives from dividend-paying stocks in its investment portfolio to fund investors. 

Are dividends irrelevant?

Some analysts consider dividends irrelevant. They argue that shareholders will benefit anyway if profits are reinvested because the share price will rise. However, given dividends and capital gains are treated differently for tax, shareholders will likely prefer one type of return over another.

Buying dividend-paying investments

Investors of dividend-paying stocks potentially benefit from both capital appreciation and dividend payments. Share investing comes with volatility, but regular dividends can reduce that somewhat. You can reinvest dividends to grow your portfolio and potentially lower your tax bill with franking credits. For these reasons, dividend investing is highly popular in Australia.