Company share dividends are a crucial part of the stock market landscape.
Dividends have traditionally been a key component both for income seekers and as part of retirement planning strategies, but they endured a rocky period during the worst days of the Covid-19 pandemic in 2020, when UK payouts fell dramatically. Since then, however, they’ve bounced back.
Here’s a look at what dividends are, why companies pay them, and what would-be investors need to consider.
What is a dividend?
A dividend is a distribution, usually in cash, paid by a company to its shareholders. The payments are met out of a company’s earnings in a given year.
Dividends are usually paid half-yearly. But they can also be paid annually or quarterly, and are usually made on a ‘per share’ basis. For example, an investor who owns 100 shares in a company that has announced a 10p dividend, would receive a payment of £10.
Dividend payments can also be made on a ‘special’ basis. These are essentially one-off payments where a company has, say, completed a large transaction.
For example, this could be where a business has sold off a particular division and wants to return some of the money to shareholders that it’s earned as a result.
Stock dividends are less common than cash dividends. Instead of cash, this is where a business issues extra shares to its shareholders. For example, a company issuing a 3% stock dividend means a shareholder would receive an extra three shares in the business for every 100 already held.
A ‘scrip’ dividend, meanwhile, is where a company offers to pay a stock dividend instead of cash. The company issuing the scrip dividend then gives shareholders a choice: cash or extra shares.
Why do companies pay dividends?
Paying a dividend allows a company to share its profits with shareholders. This is both a gesture of gratitude for ongoing support and an incentive for shareholders to continue holding their shares in a particular business.
Investors tend to view consistent dividends as a sign of a company’s strength and that a management team has positive expectations around future earnings growth. This in turn makes a company more attractive to investors, which in term helps to drive up the company’s share price.
Companies that can demonstrate a consistent and rising dividend track record are of special interest to income seekers, from individual retirees to charities to professional managers running corporate pension funds on behalf of thousands of workers.
Which companies pay dividends?
Companies are not obliged to pay dividends and plenty of successful businesses don’t.
But of the companies that do, the amount paid in dividends might range from a large proportion of earnings – usually where the company in question is established and mature – to a relatively small fraction, where a business is still young and growing.
Long standing companies are more likely to be able to afford dividend payments, whereas earlier-stage businesses may decide to hold on to their earnings to reinvest in future growth opportunities.
A start-up business, for example, would potentially need to use the lion’s share of its earnings to build products, hire staff and expand. In this scenario, paying dividends might be regarded as a poor use of available cash and potentially damage the business’s prospects.
Companies with a strong track record of paying dividends tend to be found in specific industrial sectors within the stock market. These include utilities, commodities, energy and healthcare – solid businesses with well-defined trading patterns and large customer bases, leading to consistency in profits.
Some companies pride themselves on their consistent approach to paying healthy dividends. That said, there is no guarantee that, just because a company boasts a strong track record on paying dividends, it will continue to do so.
For example, a company planning an acquisition or other investment that requires a large amount of cash might need to alter its dividend strategy accordingly.
How much do companies pay in dividends?
An immense amount. Companies worldwide made dividend payments worth an all-time high of about £1.1 trillion to shareholders in 2021, according to investment firm Janus Henderson.
This was a significant turnaround from 2020 when companies were forced to cut or suspend their dividend payments during the Covid-19 crisis.
During that pandemic-blighted year, nearly 500 companies listed on the London Stock Exchange suspended dividend payments. This included around half of those on the FTSE 100 index, the UK’s basket of leading blue chip companies. Dividend payments to shareholders in the UK fell by 44% over that period.
Since then, nine out of 10 companies worldwide have bounced back, either raising or maintaining their dividends from previous levels. In 2021, dividends from UK, Europe and Australian markets grew the fastest compared with 2020, thanks to a recovery in the mining and banking sectors.
What does ‘dividend yield’ mean?
When trying to work out the potential income from a share, investors look closely at a company’s dividend yield. This tells you how much a company pays out in dividends relative to its current share price.
For example, if XYZ plc’s shares trade at £50 and the company receives the necessary approval from its shareholders to pay an annual dividend of £2 per share, the dividend yield is 4%.
In comparison, if rival business ZYX plc’s stocks trade at £200 and its annual dividend is £3 per share, its dividend yield is much lower at 1.5%, even though investors receive a larger amount per share compared with XYZ plc.
You can find the yield figure as part of the stock market listings within the business pages of national newspapers and news websites. To check an individual company’s dividend history, head online to the investor relations section of its website.
Bear in mind that share prices fluctuate constantly, which in turn affects the yield. As a company’s price rises, so its yield falls – and vice-versa.
What is a ‘good’ dividend yield?
It’s worth remembering that there isn’t really a one-size-fits-all answer to this question. Dividends show that a company is in good corporate health because it has enough cash after investing in its business, to pay to shareholders.
But it’s important, when scrutinising a company’s prospects, to look at more than just the yield figure. Other elements to consider include the trajectory of a company’s share price, its earnings per share and price-to-earnings ratio.
The latter, often abbreviated to ‘PE ratio’, or simply ‘PE’, is a way of measuring how highly investors value the earnings that a company produces.
Two companies of similar size in the same industrial sector will normally have similar dividend yields. If one is a lot higher than the other, this could be a sign that it’s an attractive investment. Alternatively, it could be a sign of trouble. A sharply falling share price, for example, which is rarely a good sign for investors. Generally speaking, investors should beware of high and unsustainable dividends.
As a rule of thumb, dividend yields of between 2% and 5% are considered strong, and anything above this can be a great buy – but may come with risks attached.
If your focus is on receiving dividend payments from the UK’s leading companies, use the overall yield on the FT-SE 100 index – currently just under 4% – for comparison purposes and as a benchmark against individual businesses.
How are payouts determined?
Companies map out their dividend policy over time. Having acquired a recommendation on the size of the dividend from a company’s management board, the amount a business proposes to pay in dividends is then voted on by shareholders.
Paying out dividends to potentially hundreds of thousands of shareholders is a major piece of administration. Key elements in the process include:
- Declaration date. A company formally announces it’s going to pay a dividend. At the same time, it will disclose the ‘ex-dividend’ date and the payment date.
- Ex-dividend date. This is the day where potential buyers of the company’s shares stop being eligible for the upcoming dividend payment. It’s possible to continue buying shares after this date, but no dividend will be received. If you sell shares before the ‘ex-date’ you don’t receive the dividend. But if you wait until after the ex-date and sell, you will.
- Record date. Often the day after the ex-dividend date when a company determines which of its shareholders are eligible to receive dividends.
- Payment date. The day dividend payments are made to shareholders. This isn’t necessarily the day that money is received, though. Nowadays, companies pay money into shareholder designated bank accounts, although some businesses still issue cheques. If a stockbroker looks after your shareholdings, they will pass on the money to you.
How are dividends taxed?
You do not pay tax on any dividend income that falls within your personal allowance (the amount of income you can earn each year without paying tax).
You also receive a dividend allowance each year and you only pay tax on any dividend income above this allowance. The allowance for the tax year 6 April 2021 to 5 April 2022 is £2,000. Tax is not paid on dividends from shares held within a product such as a stocks and shares individual savings account.
How much tax you pay on dividends above the dividend allowance depends on your income tax band. See table 1 below. From April 2022, the UK government is raising the tax on dividend income by 1.25 percentage points to support the NHS, health and social care.
Table 1: Dividend tax rates
|Income tax band||Dividend tax rate 2021-22||Dividend tax rate 2022-23|
Not everyone in investment circles is a fan of dividends, and certainly not where payouts are regarded as excessive.
Some professional investors believe that management boards preoccupy themselves too much with paying dividends in a bid to keep shareholders on side.
In an opinion piece for the Financial Times last year, Sir Paul Marshall, the chairman and chief investment officer of hedge fund group Marshall Wace, likened generous dividend-paying to “a form of financial decadence, discouraging capital investment and stifling growth and productivity.”