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What are dividends and how do they work?
Dividends allow investors to enjoy a share of a company's earnings. Here's how they work and how they can benefit you.
When you buy stocks in a company, you’re effectively buying a piece of that company which means you’re a part-owner. As a shareholder you’re entitled to a share of the company’s earnings, which comes in the form of dividends.
Learn about the different types of dividends, how they’re applied and whether they impact your taxable income in this guide. Plus, compare a range of online stock trading platforms which allow you to start buying stocks in companies that pay dividends.
What is a dividend?
A dividend is a stock of a company’s earnings given to shareholders as a cash payment into their bank account, usually twice a year. The size of the dividend you receive is in proportion to the number of stocks you own. The more stocks you own the bigger your dividend payment will be.
For example, let’s pretend a company that sells items for household pets called Pets Galore is offering a dividend payment of $0.05 for each stock held. If you owned 1,000 stocks, you’d receive a dividend of $50. However if you owned 10,000 stocks, your dividend payment would be much larger at $500.
What is the ex-dividend date?In order to receive a company’s dividend payment, you must hold the stocks prior to its ex-dividend date. If you buy stocks on or after an ex-dividend date, you will be eligible for the next dividend payment, if there is one.
Types of dividends
There are three main types of dividends, but not all companies will pay all three types to shareholders (and some won’t pay any at all!).
- Interim dividend. This is a dividend that’s paid before the company has calculated its annual earnings. It’ll usually be paid at the same time as the company’s interim financial statements, usually six months into the financial year.
- Final dividend. This dividend payment is paid when a company announces its profits for the full financial year. Some companies will only pay a final dividend.
- Special dividend. These are bonus dividends and are typically larger than the normal dividends paid out by a company. A company may issue a special dividend to shareholders when it achieves higher-than-normal profits across a certain period.
What is the dividend yield?
The dividend yield is presented as a percentage and is an indication of the value of the dividend payment in relation to the cost of the stocks. It’s calculated by determining what percentage of the stock price is returned to the investor as income.
The dividend yield helps investors compare similar companies, as it gives you an idea of which one offers a better return on your money in the form of a dividend.
Dividend yield exampleLet’s look at company Pets Galore again with its dividend payment of $0.05 per stock.
If the current stock price was $2 per share, the dividend yield would be 2.5%. If the stock price was instead $0.50 per share, the dividend yield would be a lot better at 10%.
Because the yield is calculated using the stock price, the yield will change daily as the stock price changes.
Not all companies pay dividends
Instead of paying shareholders a dividend, a lot of smaller, newer companies will reinvest any profits made back into the company to help it grow. However, many investors are okay with this because if the company is growing, the value of their stocks will grow too.
It’s also important to note that dividends are never guaranteed. Each company decides what the value of the dividend will be and if there will even be a dividend payment at all, annually. So just because a company pays a large dividend one year, it doesn’t mean it will do this again the following year.
Paying tax on dividends
In Singapore, a single-tier corporate taxation system was introduced in Budget 2002. Under this one-tier income tax system, taxes imposed on companies’ profits are final and all dividends for shareholders are exempt from further taxation.
How does a dividend reinvestment plan work?
Some companies offer what is called a dividend reinvestment plan (known as a DRP), which allows you to opt in to using your dividends to buy more stocks in the company, instead of receiving the dividend payment in your bank account.
There are several advantages of doing this, but the main one is you’re able to use the money to buy more stocks without paying any brokerage fees. It’s also a good, passive way to increase your position in a company gradually over time with little to no effort from you. It’s a good set-and-forget investment strategy: once you opt in, it all happens in the background automatically.
One downside of opting in to a DRV is you’re unable to use that cash for day-to-day purchases like you could if you had received it into your bank account. You also don’t get to choose at what stock price you’d like to buy more: the stocks are automatically bought on your behalf on the date of the dividend payment.
How to compare dividend-paying stocks
If you’re comparing a bunch of dividend-paying companies, here are a few things to keep in mind.
- How often are dividends paid? Most companies pay out dividends four times per year on a quarterly basis. However, some companies only pay dividends once or twice a year.
- Have dividends been confirmed? Companies will often confirm their dividend payments for the year ahead in advance.
- Are dividends growing in value? Take a look back at the dividends paid by each company over previous years. If the value of the dividend has gradually increased, this is a good sign the company is growing and will likely continue to increase its dividend.
- What’s the dividend yield? Is the yield higher than what you could earn with a high interest savings account?
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