What are dividends?

Discover what a dividend is, why companies pay dividends, how they impact share prices and the value of dividends to investors.

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An introduction to dividends

Companies pay dividends to shareholders from the profit they make. It's essentially a way of rewarding them for investing in the business. 

As companies typically pass on a dividend payment to shareholders in cash, a dividend can be described as a 'cash dividend'.

Key takeaways:

  • Cash dividends are common, but companies can also pay profits to shareholders in additional shares instead
  • The dividend amount an investor receives depends on the number of shares they own
  • Dividends often come with franking credits that can lower your income tax liability.

So, how do dividends work? 

Under Australian law, a company's board of directors can authorise a dividend if they are satisfied that the company:

  • Has sufficient net assets
  • Can still pay creditors after the dividend payment
  • Is paying a dividend that is fair and reasonable.

The board must then decide how much to pay and when to distribute the dividend to shareholders. 

Not all investors consider paying out dividends the best move. Some believe reinvesting profits instead can increase a company's long-term value and deliver more significant shareholder benefits through a higher share price. 

However, others favour dividends because they want certainty and prefer receiving some income returns sooner rather than later. There can also be tax benefits for shareholders where a franking credit accompanies a dividend. 

A franking credit is a tax credit that can reduce a person's assessable income and lower their tax bill.  

You'll often come across the term dividend yield. It's a helpful metric for quickly identifying stocks that pay higher dividends. We calculate yield by dividing a company's annual dividend by its share price. 

An investor seeking dividends will also look at the dividend payout ratio and dividend history of potential stock investments.

Which companies pay dividends?

Mature companies typically have stable sources of finance, lower debt levels, and consistent profits, so they can afford to pay dividends. 

In Australia, large blue-chip companies from well-established industries such as banking and financial services, resources, and retail tend to offer higher dividends to their shareholders. 

Growth companies are likely to have higher investment expenditures and fewer sources of finance, so they tend to reinvest profits back into the business rather than distribute them as dividends.

Why do companies pay dividends?

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

Since companies typically need to be profitable to pay dividends, their payment can signify financial strength and stability. It can attract new investors and lift demand for a company's shares. 

Hence, companies with a strong dividend history are often reluctant to reduce or stop paying dividends, as this can spook investors by giving the impression of financial trouble.

Of course, how companies pay dividends is just as important as why they pay. 

While cash dividends are more common, companies sometimes pay share dividends instead. Eligible shareholders usually receive cash dividends by direct credit. Share dividends are paid by allocating additional shares to eligible shareholders. 

There are no rules regarding how often companies should pay dividends, but many ASX companies pay an interim dividend and a final dividend each year. Sometimes, a company with exceptionally robust earnings will also pay a special dividend. 

Important dividend dates

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

Declaration date: This is when a company announces a dividend to the market. The announcement will include information such as the amount the company will pay in dividends and whether it will be a cash or share dividend. It will also declare the ex-dividend date.

Ex-dividend date: From the ex-dividend date onward, a share begins trading without the value of its next dividend payment. You won't get the upcoming dividend if you buy a stock on or after this date. The ex-dividend date is usually one business day before the record date. 

Record date: This is the date set by the company upon which you must be on the books as a shareholder to receive the dividend. At 5pm on the record date, the company will close its share register to identify the shareholders eligible for the dividend payment. 

Typically, the record date is set one business day after the ex-dividend date. Because share trades take two business days to settle, you must own the stock before the ex-dividend date to be a shareholder on record on the record date.

Payment date: This is when the company pays its dividend to shareholders.

How do dividend payments affect share prices?

A company's share price might rise in the period leading up to the ex-dividend date due to higher demand from investors buying shares to qualify for the dividend. 

The company's share price will likely fall by the dividend amount on the ex-dividend date. This is because investors who buy shares are now ineligible for the dividend from this point onwards. 

Are dividends relevant?

Some analysts consider dividends irrelevant. They argue that shareholders will still benefit if profits are reinvested in the company instead of paid out to investors because the share price will rise. 

However, given that dividends and capital gains are treated differently for tax, different shareholders may prefer one type of return over the other.

Buying dividend-paying investments

Dividend investing is highly popular with Australian shareholders, with many investors relying on the cash flow from dividends to fund their lifestyle.

Investors in dividend-paying shares can benefit from both capital appreciation and income payments. Investing in shares comes with volatility, but receiving regular dividends can reduce the perceived volatility by providing an income stream and return on investment independent of share price movements.

Most dividend-paying stocks give you a choice of how to use your dividends. You can take the cash and apply any applicable franking credits towards lowering your tax bill. Alternatively, if the company offers a dividend reinvestment plan (DRP), you can reinvest your dividends in more shares. 

Investors are usually offered a discounted share price for reinvestment through a dividend reinvestment plan (DRP). Opting into a DRP allows you to grow your portfolio without thinking about it. 

If you elect to participate in a DRP, you will still need to declare your dividend income as though you received it in cash on your tax return, but you will also get the benefit of applicable franking credits.  

Most ASX-listed companies pay dividends in Australian dollars, although companies that make significant income offshore may pay in another currency, such as United States dollars. 

While investors often focus more on payments made directly to shareholders by listed companies, mutual funds and exchange-traded funds (ETFs) also pass on dividend payments in the form of distributions. 

These come from the dividends that funds receive from dividend-paying shares in their investment portfolios. Funds typically pay shareholders monthly or quarterly distributions rather than twice a year.

  • With additional reporting by Motley Fool contributor Kate O'Brien

Frequently Asked Questions

When a company distributes a portion of its profits to shareholders, that is known as a dividend payment. Imagine an ASX-listed company has had a profitable year and decides to share some of these profits with its shareholders. It announces a dividend of $1.00 per share. If you own 100 shares in the company, you will receive a dividend payment of $100 ($1.00 per share x 100 shares). Alongside the cash payment, the business might also provide franking credits, which are tax credits that can reduce your income tax liability in Australia. These credits are particularly valuable to Australian taxpayers, as they prevent the double taxation of dividends – first at the corporate level and again at the individual level.

You can check your bank account statements, as dividends are typically paid directly into the bank account you have registered with your brokerage or the company's share registry. Some brokerages or share registries offer email notifications for dividend payments. If you've opted in for this service, you will receive an email each time a dividend is paid on your shares. 

If you hold your shares through a brokerage account, you should receive regular account statements either online or by mail. These statements will detail any dividend payments you have received for the shares you own. If you manage your investments through an online brokerage platform, you can log in to your account and view your transaction history. This history should include records of all dividend payments.

While dividend investing can offer a steady income stream and potential tax benefits, it's essential to be aware of its downsides. Dividend-paying companies might have lower growth potential as they reinvest less profit back into their business. Income stocks can be sensitive to interest rate changes, which can negatively impact share price values when rates rise. Additionally, dividend payments are never guaranteed. A company can reduce or stop paying them altogether if it faces financial difficulties. Focusing too heavily on dividend stocks can also lead to a lack of diversification in your investment portfolio, increasing your exposure to specific market risks.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.