Previous article – 6 Money Lessons Learnt in Lockdown to Continue Using
Freetrade referral link – sign up and earn yourself a free share worth up to £200
A dividend is an agreement by a company’s board of directors to pay shareholders a sum of their profits as a ‘reward’ for the investor’s commitment and capital risk.
How much an investor receives in dividend payments is determined by how many shares they hold of that company. This is why you’ll often see dividend payment information shown in the form of how much the investor will receive per share (in pennies).
You can almost think of it like the interest you receive on your savings account.
Much like savings interest rates, companies can reduce or increase their dividend payout, or at times, even postpone or stop paying a dividend entirely.
We saw a number of examples of this last year when the Coronavirus started taking hold.
A (very) brief history
Dividend payments to investors can be dated back as far as the Dutch East India Company (VOC) back in the 17th and 18th centuries.
Incredibly, the VOC paid a regular dividend of 18% over their almost 200 year existence.
Considering the current average dividend yield of FTSE 100 companies is 2.91%, this is quite impressive.
What is a dividend yield?
The dividend yield is simply the percentage of the stocks current price that will be paid out to investors.
For example, if the share price is £100, and the dividend yield of the share is 5%, the investors will receive £5 per share.
Why companies offer dividends
Some companies will choose not to offer a dividend, and this may initially appear to be a less attractive company to invest in as a result; with a dividend paying company you could benefit from the rising share price AND a small payout depending on the number of shares you hold.
But a company committing to paying a dividend is often (not always) a sign of an older, more stable company with a regular and reliable cashflow and profit. So this may be an indicator that the company is expecting less growth than those who don’t pay one.
Of course, this is all ifs, buts, and maybes as a dividend paying company could also experience considerable growth in their share price.
Disney are a decent example of this over the last few years. Since May 2018 their share price has almost doubled, but still pay a regular, twice-yearly dividend.
On the flip side you have Tesla. Despite their rapid rise over the last 5 years, Tesla are still looking to increase their position as the world leader in electric car manufacturing and battery energy storage.
Tesla’s most pressing goal is increased growth, so any profits made will be going back into the company rather than a portion of that being paid out to investors.
Those who invest in Tesla are foregoing the small, regular dividend payment in the hope that they can sell their shares for a larger profit in the future. Paying a dividend would limit the amount of money Tesla can pump back into the company in order to support this growth goal.
Smaller growth companies also often don’t turn a profit for the first X years of their existence. Without turning a profit, companies can’t pay a dividend.
Dividends are more common in sectors such as:
- Basic materials
- Oil and gas
- Banks and financials
Types of dividend
There are a number of different types of dividend.
The vast majority of people reading this, will probably only ever come across the first one, but I’ll list them all nonetheless.
- Cash dividend – this is the most common form of dividend payment. A company will pay their investors a set amount of cash depending on the amount of shares they hold. The investor will typically set up instructions on where they want this paid to.
- Stock dividend – a company may choose to pay out dividends in the form of more shares. However, an investor receiving this form of dividend doesn’t now own a larger portion of the company. For example, an investor owns 100 shares. They then receive a 10% stock dividend where they now own 110 shares. The investor may now own 10% more shares, but each share is priced 10% lower. In effect, a stock dividend is like a mini stock split. It doesn’t add any real value to the shareholder. Over the past two decades, the frequency of stock dividend payouts has dropped substantially.
- Property dividend – this is a ‘non-monetary’ form of dividend payment. A company may decide to pay the dividend in the form of a physical asset, rather than monetary asset. The shareholder can then decide to keep that physical asset, or sell it on.
- Scrip dividend – a Scrip dividend is a promise to investors to pay a dividend at a later date. The company may not have the liquidity at the time to fulfil their dividend payments, so will agree to pay an investor in the form of a promissory note.
- Liquidating dividend – this form of dividend payment may occur when a company is considering wrapping up the business. All original capital will be returned to investors.
There are a few specific terminologies when looking into dividends you may want to be aware of.
- Announcement date – this is the date the company announces its intention to pay a dividend. This must be agreed by the shareholders beforehand.
- Ex-dividend date (Ex-div) – this is the deadline you need to buy shares before in order to receive a dividend on the next payment date. For example, if the Ex. Div date is 2nd April, you must purchase shares on or before 1st April to receive the next dividend payment. As long as you purchase or hold shares before this date, you will receive a dividend, even if you sell your shares after the date has passed, but before the dividend has been paid.
- Record date – this is the cut-off date where individuals will no longer be considered for the next dividend payment.
- Payment date – this is the date the dividend is paid/credited to the shareholders.
Things to consider
On the outset, dividends seem like a win/win.
Your share value could rise AND you receive a small ‘interest’ payment; furthermore, even if the share value drops you’ll still receive some form of income.
But a company paying a dividend is not always a guarantee of stability. Like with any investment, it’s incredibly important to do your own research on how financially stable you believe the company to be.
However, dividend paying companies can make up part of a well-rounded and diversified portfolio, giving you a form ‘investment cashflow’ in order to regularly distribute small amounts of cash back into the rest of your portfolio.
Especially with newer investment apps like Freetrade – who notify you through your phone when a dividend has been paid – it’s always nice to be down the pub and receive a notification that Unilever has just paid you a fiver…”drinks all round”.