Diving into Dividends

Dividends are important returns made to sharemarket investors. We break it down and take a look at some of the terminology involved.

What is a dividend?

When it comes to share investing, dividends can provide a valuable source of income. Dividends represent a distribution of some of a company’s earnings or reserves to eligible shareholders. While typically dividends are paid in cash to shareholders, they can also be paid out in the form of additional shares. 

Dividends allow investors to share in the profits that the company has made. But it is important to note that cash-based dividends do not always have to be linked to how much profit a company makes. Companies can also pay cash-dividends even if they make a loss. The company may take the view that any loss recorded will only be temporary and at the same time it may express confidence about its future financial performance.

It is also worth pointing out, that to attract and retain shareholders, some companies place a high priority of paying dividends regularly. 

Companies usually declare dividends on a ‘per-share’ basis, so the more shares you own, the more dividends you are entitled to receive. Some dividends have franking credits attached.  Franking credits may lower your income tax liability in the year you receive them.  

When do companies pay dividends?

Generally, companies make decisions on dividend payments when issuing the latest financial accounts. For large companies this is typically twice a year. But real estate investment trusts (REITS) may pay returns four times a year. 

It is important to note that companies don’t have to pay dividends – the company’s Board makes a strategic decision on the best use of retained earnings or reserves. For instance, the company may instead wish to pay down debt, reinvest the funds back into the business or hold funds in reserves with the possibility of engaging in future mergers or acquisitions.

Dividends don’t need to be just paid at specific times of the year. Sometimes, as an added bonus for shareholders, a company can declare a special dividend. This may occur when the company has sold assets or made non-recurring or windfall profits and the Board determines that shareholders can receive a share of the gains.

What are franking credits?

The terms “franking” and “franking credits” are regularly mentioned in discussions on dividends. That’s because they impact the amount of tax the shareholder pays in relation to the dividend. In addition, some shareholders are able to claim a refund of a portion of the franking credit in certain circumstances. 

The earnings of a company (which are subsequently distributed by way of dividends) may have already been subject to tax, which is currently 30 per cent for listed companies.

When a company pays a dividend that includes a franking credit, the dividend is described as being 'franked'. Franking credits are also known as imputation credits. 

The dividends that you receive may form part of your annual taxable income and may give rise to a tax liability and PAYG instalment obligations.

The tax considerations associated with dividend payments can be important for shareholders, especially if the tax payments impact on their household budgets. You should consult your accountant, tax advisor or the ATO for more information on how dividends and franking credits may impact on your tax position. 

Important Dividend Dates:

It’s also important that you’re aware of key dividend payment dates, these include:

•  Declaration Date: When the company announces a dividend.

•  Ex-dividend Date: The trading date before which you must purchase the company’s shares to receive the dividend.

•  Record Date: The day after the ex-dividend date, when the company checks its record to identify shareholders.

•  Payment Date: When the dividend gets paid to shareholders.  

In practical terms, when a company trades ex-dividend, for example, its share price is likely to fall by the dividend amount because investors who buy shares after the ex-dividend date are ineligible for the dividend payment. 

Bottom line:

Dividends can play an important part in your overall portfolio as they can help you reach your investment goals.

Dividends are returns made by companies to their shareholders in the form of cash or shares. For some investors, dividends are a fundamental reason for investing in shares. Other investors – especially those with longer time horizons – may be less focused on dividends and more concerned about the growth of the company’s share price over time.

Large ‘blue chip’ ASX-listed companies within the financial services, resources, consumer discretionary/staples sectors and REITs have typically paid higher dividends to their shareholders. On the flip side, growth-orientated companies with higher investment spending and fewer sources of finance may reinvest rather than distribute profits. 

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