The buyer of a share can recoup their investment in two ways: by selling the share at a later time for a higher price or through dividends. However, before investing with a focus on dividends, it is important to have a good understanding. Therefore, we will explain everything in this article!
What is Dividend?
Dividend is a profit distribution to shareholders. When a company makes a profit, the shareholders, as co-owners, are entitled to a portion of the profits. Usually, the amount of dividend is determined based on the company's earnings.
Why Would a Company Pay Dividends?
When a company makes a profit, it has two choices: reinvest the profit in the company itself or distribute it as dividends. Reinvesting profits can improve business performance and increase the company's value, making the shares more valuable. In the case of distributing dividends, shareholders receive direct money from the company, keeping them satisfied. Additionally, it signals that the company is doing well since they demonstrate not needing all the money, which can attract more external capital for further growth. The company could reinvest this external capital in the company and grow with those investments.
Different Types of Dividends:
- Cash Dividend: The most common form where money is paid out to shareholders.
- Stock Dividend: New shares are issued to shareholders. If only stock dividends are issued, it is practically equivalent to splitting existing shares.
- Scrip Dividend: The company gives shareholders a choice between cash or stock dividend. Those opting for cash will receive money, but their shares will be less valuable as the company's value is distributed over a larger number of shares.
- Property Dividend: Rarely used; the company may issue certain products as dividends.
- Dividend in Specie: Occurs when the company splits, and shareholders receive shares in two different companies.
- Liquidation Dividend: Applied when the company dissolves, distributing all assets (minus debts) among shareholders.
Frequency and Dates of Dividend Payments:
The company decides when to pay dividends, usually annually or quarterly. Sometimes, special occasions may warrant extra dividend payments. The dividend calendar is usually on the website of the company. Some key dates include:
- Announcement Date: The day the company announces when and how much dividend will be paid to shareholders.
- Ex-Dividend Date: Shareholders before this date have the right to receive dividends. Buying shares on or after this day means the previous owner retains the right to dividends.
- Record Date: The broker determines who is entitled to dividends on the ex-dividend date.
- Payment Date: The date when dividends are actually paid to shareholders.
Tax Implications of Dividends:
The amount of tax on dividends varies by country. In the Netherlands, a straightforward system is employed: a 15% tax is levied on dividends. For example, with a €1 per share payout, you would keep €0.85 after taxation.
Example of Dividend Payout:
Suppose a company has five shareholders, each owning 20% of the shares before the ex-dividend date. The company makes a profit of €100,000, with the board deciding to reinvest €50,000 and distribute €50,000 as dividends. Each shareholder will receive 20% of this dividend, in this case, €10,000. After tax, this amounts to €8,500 (€10,000 * 0.85).
What is Dividend Yield?
Dividend yield is a crucial metric to determine if an investment for the purpose of receiving dividends is advantageous. It is calculated using the formula: 'Dividend Paid / Purchase Price of the Share * 100'. In practice, if a company pays €5 in dividends and the share's purchase price was €100, the dividend yield would be 5% (5/100*100).
More Questions?
If you want to learn more after reading this article, feel free to explore our knowledge base or participate in one of our informative webinars on employee participation!