Most investors (and especially short-term traders) are focused on share prices rising so that they can make a capital gain.
In doing so they forget about dividends and the passive income that dividends generate.
Unfortunately for them, it has been proven many times that it is the receipt of dividends and their re-investment into buying more shares that creates the biggest gains over time for longer-term investors.
This article therefore examines dividends more closely and explains how they work.
What Is A Dividend?
Dividends are payments made by a company to its shareholders, similar to a bank paying interest on your savings.
There are different kinds of dividend but the most common type are paid to the holders of ordinary shares – people like you and I.
It is these ordinary dividends that I am going to focus on in this article.
When Are Dividends Paid?
If a company pays dividends to its shareholders, it is normal to pay them twice a year, after the full year (final) and half year (interim) results.
However, this is not always the case.
Sometimes dividends are paid only once.
When this happens, they usually follow the final results.
Dividends paid after the final results are known as final dividends and those paid after the interim results are known as interim dividends.
Some companies pay dividends four times per year along with their quarterly results, however this is unusual.
Why Do Companies Pay Dividends?
Companies need shareholders to invest money into their business so that they can grow.
But investors are not stupid.
Investors will only put their money into a business if they believe they will enjoy a good return on their investment.
One way of earning a return is from a rising share price but this gain can only be realized when the shares are sold.
So what about earning a return in the meantime, while the shares are still being held by the investor?
That is what the dividends are for.
Every company traded on a stock market has a dividend policy.
This dividend policy can change from time to time but usually stays the same for a few years, at least.
It states whether the company will pay its shareholders a dividend or not.
It states how often it will pay a dividend – annually, twice a year or quarterly.
It also includes a formula which helps it to work out how much dividend to pay each time.
What Are Special Dividends?
There are also dividend payments called a special dividend.
These are only paid occasionally by companies that have an abundance of cash and want to return some of it to their shareholders.
A company may have a sudden influx of cash when it sells off a part of its business, for example.
So a special dividend is really a one-off extraordinary dividend payment and not intended to be repeated regularly.
The company could have just raised its final or interim dividend instead but companies generally prefer to leave these payments alone in line with their agreed dividend policy.
That’s because shareholders like stability and a steady and slowly increasing dividend payment, over time.
This builds confidence in the shares and the management of the company.
So returning cash to shareholders in the form of a special dividend sends the signal that this is a one-off payment.
I hope you’ve enjoyed this article – if you have, please leave me a comment below or share it with your friends and contacts.
Until next time…