What are dividends?

What are dividends, what are the different types and what should investors be aware of?

The most important facts in brief Dividends are profit distributions from companies to their shareholders. At the annual general meeting, shareholders with voting rights decide how a company's profits are to be used and whether a profit distribution should be made. A high and constant dividend yield can indicate economically healthy companies, but the significance of this indicator is limited without taking other factors into account.

1. Basics

At the annual general meeting, the shareholders of a listed company decide how the profits generated by the company are to be used. Here, owners of shares with voting rights can decide whether and in what amount a portion of the profit is distributed as a dividend. In the event of a distribution, the owners of company shares will participate in the profits of the public limited company. The amount of the dividend is influenced by the economic situation, the earning power and the dividend policy of the company.

While companies based in Germany usually pay out any dividends once a year, distributions can also take place monthly or quarterly. The latter is often the case with listed US companies.

In the case of German stock corporations, the day after the annual general meeting is usually referred to as the ex-dividend day, since anyone who buys shares in the company on this day is no longer entitled to the dividend provided for the past financial year. On the other hand - in the event that a resolution for the distribution of a dividend has been made - all shareholders holding shares in the respective company on the day before the ex-day are entitled to receive the dividend payment. The actual payment will be made at a later date, to those same shareholders. New shareholders can therefore acquire the share more favourably after the ex-day, as they are no longer taken into account for the distribution of the past business year. Accordingly, the share trades at a lower price. This explains the decline in the price on the ex-date of a share. In US companies with several distributions per year, there are several ex-days independent of the annual general meeting. In technical jargon, a share is said to be "trading ex-dividend" on such a day.

2. Dividend stocks in a portfolio & dividend yield

In addition to possible price gains, profit distributions in the form of dividends can also make a significant contribution to the return on an investment. Dividend stocks can generate additional, regular income. In principle, shareholders with a focus on dividend stocks often pay attention to the fact that companies pay dividends regularly and at a relatively constant level. Rising dividends in the past can also be an indication of sustainable growth in corporate profits.

The following chart illustrates the influence of dividends on the performance of the S&P 500 Index:

Dividends and share prices - the sum makes the difference

Average annual return of the S&P 500 Index in different decades

Note: Neither past performance nor forecasts are a reliable indicator of future performance. Source: Bloomberg

In addition to the price-earnings ratio or sales growth, the dividend yield is another key figure used in equity analysis and company valuation. It displays the expected dividend in relation to the share price.

The dividend yield of a share can be calculated using the following formula:

Dividend ÷ Share price x 100 = Dividend yield (%)

A high or rising dividend yield is not necessarily a good sign, but can also be interpreted as a warning signal. Even with a rising dividend yield, a company may be in an economic predicament. This is because if share prices fall and the dividend remains the same, the dividend yield will rise. In addition, high dividend payouts by companies can be an indication that the company can not find any attractive investment opportunities for further growth, which means the profits that are generated are primarily distributed.

As a general rule, high dividends or dividend yields are no guarantee of success for an investment and in isolation have too little significance to determine the quality of a share. Before deciding to invest in dividend-paying individual stocks, one should also analyse other key metrics.

3. Types of dividends

Profits can be distributed in different ways:

Cash dividend- In the case of cash dividends, the profit share is paid directly into the shareholder's clearing account.

Stock dividend - In the case of stock dividends, the shareholder receives additional shares in the company as a dividend. This can be an advantage, especially in the case of foreign dividends, because in contrast to cash dividends, no withholding tax is due here and shareholders do not have to worry about the refund of the withholding tax, which usually involves a great deal of effort. The type of dividend is usually decided by the company, not by the investor.

Dividend in kind - Here you receive non-cash assets from the company. These can be, for example, products of the company. A well-known example is the dividend in kind at Lindt & Sprüngli: it consists of a suitcase filled with chocolate bars and chocolates.

Overview

Basics
Dividend stocks in a portfolio & dividend yield
Types of dividends

Markus Kirchler

Markus is a Senior Analyst in the Capital Markets team. His main areas of expertise are portfolio management and ETP trading. He holds a Bachelor's degree in Economics from the Free University of Bolzano.

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