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Fool School

FOOL SCHOOL
Dividends

November 5, 2001

One of the joys of investing is hearing the thud of the dividend cheque when it comes through your letter box. But it's a subject that often confuses.

What are dividends?

A company exists to allocate its resources in the most efficient manner for the long-term benefit of its shareholders. Each year, hopefully, it will make a profit. Typically it will keep some of its profits back in order to expand the business or to cushion its own cash position. It will pay the remainder to its shareholders via a dividend.

A company's management decides how much each dividend payment will be. Once it is declared it is paid to every shareholder. But companies are under no obligation to pay a dividend of any set level.

Younger companies in growth markets are far more likely to pay a small or no dividend so that they can fund further expansion. In contrast more mature companies in slower growing markets are likely to pay higher dividends because they do not have the opportunity to invest in expansion. Most companies try to steadily increase their dividends each year as this is what most investment institutions prefer to see.

How and when are they paid?

In the UK dividends are normally paid twice a year, after a company's interim and full-year results. A typical split is one-third at the interim stage and two-thirds at the year-end. Some larger companies pay out dividends each quarter.

When a company publishes its results, normally between one and three months after the end of the period, it will declare how much and when the dividend payment will be. The exact date of payment will vary from year to year, although last year's payment date should give a rough indication of when you should expect your lolly. When a dividend declaration is made the company will announce three dates alongside the payment. These are the ex-dividend date, record date and payment date.

The difference between the first two is to simplify the bookkeeping of the registrars when millions of shares are being traded every day and numerous transactions are half-completed. The first date is when shares go ex-dividend: in other words, only shares bought before that date entitle their owners to that dividend payment. And, as we might expect, on that date the share price generally falls by the amount of the dividend that they were entitled to.

The record date is the actual date when the registrar actually tells the company who to write the dividend cheque to: that is, who is the beneficial owner of the shares. And finally, payment date is just what it sounds like.

This means if you buy the shares between the ex-dividend date and the payment date then you won't be entitled to that dividend. In newspapers this is often denoted by the letters 'XD' (pronounced ex-div) next to the share price. If you sell the shares on or after the ex-dividend date you are still entitled to receive that dividend.

If you do happen to trade in the shares around this time you might want to double-check that you do receive the dividend, if you are entitled to it. Companies do sometimes make mistakes!

Why Dividends Are Important

Dividends are a key element of overall returns from shares. The other element is the increase in the share price. If you want to get the full benefit of the superior long-term returns that shares offer you need to reinvest your dividends. This article has more details.

More: Dividend Yields And Dividend Cover


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