Dividends - Income from your investment
In this article we will take a closer look at the role dividends play in an investment
For a stock, a dividend is a payment made by the company to its shareholders. The payment is generally (although not always) a portion of the profits that the company has made.
For a fund, a dividend is the distribution of dividends the fund has received from the securities that it holds.
What makes up a dividend?
If you are interested in researching stocks or funds that pay dividends there are some key data items that you should look at.
Ex Date – The date on which an investor must hold the stock or fund to qualify for the dividend.
Pay Date – The date on which an investor receives the dividend
In the period between the Ex Date and the Pay Date, a security is described as ex-dividend or XD. This annotation is used to reflect the fact that the security is in the process of paying a dividend and the price has fallen to reflect this payment.
Rate – The amount of money paid to the investor for each share that they own.
Yield – A measure of how much a stock or fund has paid out in dividends over the previous 12 months compared to the current price.
Yields are calculated on dividends that have been paid in the past 12 months compared to the current price. If the price has fallen significantly, the reported yield of a security will be inflated to an unrealistic level.
For example the current quoted yield on many sites for Lloyds Banking Group is around 60% (total dividends in 2008 = 36.1p, current share price = approx 60p!)
An example of a more realistic dividend yield, however, can be explained using United Utilities, which paid out 46.7p in 2008 and currently trades at 524p per share, therefore yielding 8.9% last year. The utility group’s dividend for 2009 is expected to be in the region of 33p, which would bring the total yield for the current year down to 6.2% if analyst forecasts are correct.
Remember that dividends are based on company profits – they are not guaranteed. In difficult times companies may suspend dividends to preserve cash to help them through.
What options do I have when I receive my dividend?
When you have received a stock dividend, you will typically have three options.
- Pay the income away to a nominated bank account
- Hold the income in your share account. The cash can then be used to finance the purchase of other shares
- Automatically reinvest the dividend in the stock that paid it. When selecting this option an investor will usually only have to pay stamp duty on the transaction rather than the usual broker dealing fees and stamp duty
The effect of reinvesting dividends
Reinvesting the income you receive to buy more of a stock or fund has a similar effect to that of making regular investments, as looked at in last week’s article: you will hold more units of a security while the amount you have invested remains the same.
When looking at the performance of an investment, this is referred to as the difference between the price return and the total return. Over time this effect can be quite marked.
A price return is calculated by dividing the price of your investment at the point you will notionally be selling it, by the price you paid for it originally, expressed as a percentage. For example:
Price paid = 100p
Price sold at = 105p
Price return = ((105/100)-1)*100 = 5%
A total return factors in the dividend in the following way:
Price paid = 100p
Dividend received = 2p
Dividend reinvestment price = 104p
Reinvestment factor = 1+(2/104) = 1.02
End price = 105p
End price including dividend = 105*1.02= 107p
Total return = ((107/100)-1)*100 = 7%
