What is a dividend?
When a company makes a profit, it can choose to either retain some of it for future expansion or it can make a dividend payment to shareholders. In simple terms, a dividend is a portion of a company’s profit that it decides to pay out to shareholders, in return for their investment. In Australia, many companies listed on the Australian Stock Exchange (ASX) will generally pay dividends twice a year, usually referred to as an ‘interim dividend’, paid halfway through their financial year and a ‘final dividend’, paid at the end of their financial year. Companies are not limited to this and can choose to pay dividends more or less frequently. However, the twice a year option is most common.
A company may not pay a dividend at all if they have failed to make a profit or have chosen to reinvest profit back into the business.
As was evident this year, particularly due to the impact of COVID-19 on businesses, many companies who had previously paid out dividends either decided to reduce them or not pay at all this time around. A reduction in dividend payout was particularly evident amongst Australia big four banks.
Why chase a dividend?
Shareholders of stocks are often very interested in the dividend payments as it often forms a substantial percentage of their income. This is particularly so for retirees who often rely on these payouts as contributing toward a high percentage of their income for the year.
Also, in Australia, franking credits make these dividend payouts even more appealing.
Dividends are paid out of profits which have already been subject to Australian company tax which is currently 30%. This means that shareholders receive a rebate for the tax paid by the company on profits distributed as dividends. These dividends are described as being ‘franked‘. Franked dividends have a franking credit attached to them which represents the amount of tax the company has already paid. Franking credits are also known as imputation credits.
Individual taxpayers are entitled to receive a credit for any tax the company has paid. If your top tax rate is less than the company’s tax rate, the Australian Tax Office (ATO) will refund you the difference.
See the following link for a list of the top 25 ASX dividend stocks with a yield over 5%. At this time, some of these stocks include: Whitehaven Coal Ltd, Fortescue Metals Group Ltd, National Australia Bank Ltd and Charter Hall Retail REIT.
Source: https://kalkinemedia.com/au/dividend-yield 27/09/2020
Dividend pros
One of the most compelling cases for dividend investing, is that it provides a significant source of income for investors, while at the same time features attractive long-term returns. Typically, stocks that pay dividends are larger, more established companies. However, while these firms have the ability to either continue or increase payouts, they do not always feature the highest dividend yield.
As bank interest rates are so low, dividend yields often far exceed returns which can be found on term deposits. From a quick scan of returns on two-year deposits in NSW Australia, it seems that you would be lucky to get any more than 1.45% per annum.
Dividend cons
A high dividend yield may indicate a company that has had a significant price fall. Also, some companies who do not want to suffer the wrath of the investor may continue to payout dividends even though the health of the company is at risk.
As always though, an investor should do some due diligence up front to ensure that their investments is sound for the long term. Review the financial health of a company before investing in them. This includes seeing if there has been any recent major news announcements which may uncover items of interest that are possibly going to impair the company’s future growth.
What are the dividend aristocrats?
You may have heard of the ’Dividend Aristocrats’. The Dividend Aristocrats are companies in the US S&P 500 Index (the S&P 500 Index or the Standard & Poor’s 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies) that have improved their annual payouts every year for at least 25 consecutive years. It’s a mix of household names as well as companies with less name recognition that nonetheless play an important role in the American economy.
In 2020, some of these companies include: 3M, A.O. Smith Corp, Abbott Laboratories and AT&T.
My take on dividends
With regards to dividends, my thoughts are that they play a more important role as you get closer to retirement. Whilst you are still young, say in your 20’s -> early 50’s, it is more important to focus on growing your wealth in growth stocks that are less likely to pay out a dividend but rather invest back into their own business. Once you are retired though, your aim is to preserve your capital whilst still aiming to secure an income for the year. As this is the case, it makes good sense to invest in solid companies that pay a regular dividend.
Your PROFITABLE ACTION STEPs this time around:
- Review your investments ongoing. At the very least, review performance on a six-monthly basis. Know where your superannuation (or your 401(k) scheme in the US) is invested. If you are in the younger age bracket, err on the side of high growth rather than being defensive. Let the magic of compounding do its thing.
- If you haven’t read this article on the “Rule of 72”, you will find it an interesting read.
Stay safe, healthy and wise and most importantly of all, take ACTION.
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