What Are Dividends?

Dividend Stocks: A Cornerstone of Income Investing 

Dividend-paying stocks have long been a cornerstone for investors aiming to generate income, particularly those planning for retirement or seeking to earn a steady living from the stock market. But is relying on dividends the most effective way to grow your wealth through shares? If you're venturing into the stock market, understanding how dividends work and why companies offer them is crucial for refining your investment strategy. 

The Basics of Dividends 

Investors can profit from owning shares in two main ways: by capitalizing on the company’s growth, which increases the share price over time, and by receiving dividends—a regular income stream paid out to shareholders. 

What Are Dividends? 

Dividends are portions of a company’s profits distributed to shareholders as a reward for their investment. If you hold shares in a company that pays dividends, you’ll receive a portion of these profits based on the number of shares you own, either in cash or as additional or discounted shares. 

Each company decides whether to pay dividends, how much to distribute, and how often to do so. These payments can be monthly, quarterly, annually, or even as one-off ‘special’ dividends. Publicly traded companies on the Australian Securities Exchange (ASX) typically pay dividends twice a year, following their full and half-year earnings announcements. 

How Much Do You Get Paid? 

The payout you receive depends on the number of shares you own. The dividend amount is usually expressed as a value per share, such as 30 cents per share, and varies significantly depending on the company’s profitability. 

Tax Implications of Dividends 

Yes, dividends are considered taxable income. However, if you receive fully or partially franked dividends—where the company has already paid some or all of the tax—you may be eligible for tax credits that can offset your personal income tax. 

Understanding Dividend Yield 

Dividend yield is a ratio that helps investors assess the potential return on investment for each dollar spent on a stock. It's expressed as a percentage, calculated by dividing the annual dividend per share by the current share price. 

While high yields might seem appealing, they can signal higher risk. For instance, if a company pays $2 in annual dividends per share and its share price is $20, the yield is 10%. However, if the share price drops to $10, the yield doubles to 20%, which could indicate underlying issues with the company, potentially jeopardizing future dividends. 

How Dividends Work 

When a company decides to pay dividends, the process generally follows these steps: 

1. The company’s leadership and board determine the profit amount to be distributed and approve the dividend payment. 

2. The company announces its intention to pay a dividend, specifying the value per share or offering alternative options like a dividend reinvestment plan (DRP). 

3. An ex-dividend date is set—this is the cutoff date for purchasing shares to be eligible for the dividend. 

4. The company schedules a payment date, typically about a month after the ex-dividend date. 

Why Do Companies Pay Dividends? 

Companies that consistently pay dividends do so to attract and retain investors who prioritize income from shares. Offering dividends, especially in the form of discounted shares, encourages shareholders to reinvest in the company. 

Dividends also serve as a signal of financial strength. Companies that can afford regular dividend payments are often perceived as stable and well-established, which can boost investor confidence and drive up the stock price. 

Companies That Don’t Pay Dividends 

Younger or rapidly growing companies may choose not to pay dividends, focusing instead on reinvesting profits into expansion, product development, or research. Even some of the world’s most profitable companies, like Google, have never paid dividends, preferring to reinvest profits to enhance long-term growth and share value. 

Exploring Dividend Investing 

If you’re considering dividend investing, start by researching publicly listed companies with a history of dividend payments. Many share trading platforms offer tools to help identify stocks with consistent dividends and high yield ratios. You can also explore individual companies’ investor relations information and annual reports, or use the ASX Dividend search tool to examine past and current dividend announcements. 

Dividend Stocks vs. Dividend Funds 

To earn dividends, you can invest directly in individual shares, choose exchange-traded funds (ETFs), or opt for a managed fund that focuses on dividend-paying assets. 

Managed funds, overseen by professional managers, offer diversified portfolios but may come with higher fees and specific conditions. ETFs, also diversified investment vehicles, are traded like shares and may include dividend-paying stocks within their portfolios. 

For those self-managing their portfolios, purchasing individual dividend stocks is straightforward, though building a diversified portfolio this way can be more costly and time-consuming.