Wednesday, December 4

Understanding Dividends: Types, Yield, and Their Importance in Investing

Dividends are regular payments of profit made to investors who own a company’s stock. Not all stocks pay dividends.

Dividends are a portion of a company’s earnings that are distributed to its shareholders on a regular basis, usually in the form of cash payments or additional shares of stock. Dividends are typically declared by a company’s board of directors and are paid out of the company’s profits or retained earnings.

Dividends are often seen as a way for companies to share their financial success with their shareholders, and they can be an important source of income for investors who hold dividend-paying stocks. Some investors seek out companies with a history of paying consistent and growing dividends, as this can be a sign of financial stability and a commitment to returning value to shareholders.

It’s important to note that not all companies pay dividends, and even those that do may not pay them consistently or at a high rate. Additionally, there are other factors to consider when evaluating a company’s financial health and potential as an investment beyond just its dividend history.

1. Basic

During the annual general meeting, shareholders of a publicly traded company decide how to use the profits earned by the company. Shareholders with voting rights can vote to distribute a portion of the profits as dividends. Dividends are payments made to shareholders as a share in the company’s profits. The amount of the dividend is influenced by factors such as the company’s economic situation, earning power, and dividend policy.

In Germany, companies usually distribute dividends once a year, but in the US, it is common for dividends to be distributed monthly or quarterly. In German companies, the day after the annual general meeting is known as the ex-dividend day. Anyone who buys shares in the company on this day is not entitled to the dividend for the past financial year. However, shareholders who owned shares in the company before the ex-dividend day are entitled to receive the dividend payment at a later date. New shareholders can purchase shares at a lower price after the ex-dividend day, as they are not entitled to the past year’s dividend. This can lead to a decline in the share price on the ex-dividend day. In US companies with multiple distributions per year, there are several ex-dividend days independent of the annual general meeting.

2. Portfolio and Dividend Yield of Stocks

Aside from potential price appreciation, dividends can also play a significant role in investment returns. Owning dividend stocks can provide additional, regular income. Shareholders who focus on dividend stocks usually prefer companies that pay dividends consistently and at a relatively stable rate. A history of increasing dividends may also suggest sustainable growth in corporate profits.

The chart below demonstrates the impact of dividends on the performance of the S&P 500 Index:

The dividend yield, alongside price-earnings ratio and sales growth, is a crucial metric in equity analysis and company valuation. It indicates the expected dividend amount relative to the share price.

To calculate the dividend yield of a share, use this formula:

Dividend ÷ Share price x 100 = Dividend yield (%)

A high or increasing dividend yield is not always a positive sign and can be a warning signal. A company may be in financial trouble even if the dividend yield is rising. This is because if share prices decrease while the dividend remains unchanged, the dividend yield will increase. Additionally, high dividend payouts may suggest that the company is unable to find attractive investment opportunities for further growth, resulting in the profits being distributed to shareholders.

High dividends or dividend yields alone do not guarantee successful investments and have little significance in determining the quality of a share. Before investing in dividend-paying individual stocks, other key metrics should be analysed.

3. Types of dividends

Profits can be distributed in different ways:

Cash dividend– In the case of cash dividends, the profit share is paid directly into the shareholder’s clearing account.

Stock dividend – In the case of stock dividends, the shareholder receives additional shares in the company as a dividend. This can be an advantage, especially in the case of foreign dividends, because in contrast to cash dividends, no withholding tax is due here and shareholders do not have to worry about the refund of the withholding tax, which usually involves a great deal of effort. The type of dividend is usually decided by the company, not by the investor.

Dividend in kind – Here you receive non-cash assets from the company. These can be, for example, products of the company. A well-known example is the dividend in kind at Lindt & Sprüngli: it consists of a suitcase filled with chocolate bars and chocolates.