Dividends

What is a dividend?

A dividend represents a fraction of a company’s profits that’s paid out to shareholders as a reward for investing in their company. Dividends are normally paid as cash, but shareholders can sometimes opt for extra shares instead. The payments will often vary over time and are not guaranteed.

How do dividends work?

A company’s board of directors are in charge of setting out the dividend policy. The dividend amount per share is then subject to approval by shareholders at the annual general meeting (AGM).

Investors must hold shares at market close the day before the ex-dividend date to be entitled to the declared dividend from those shares. Shares purchased on or after the ex-dividend date and shares sold before the ex-dividend date will not qualify for that dividend. Buying the shares just before the ex-dividend date isn’t an easy way to make a profit. After the share goes ex-dividend, the price will usually drop to reflect the amount of money leaving the company’s books, all else being equal.

What is a dividend example?

Company ABC plc has had a stellar year and the board of directors agree to reward shareholders with a dividend of 50p per share. The current share price for ABC plc is trading at £10. Upon market opening on the ex-dividend date, the share price will drop to £9.50 to account for the 50p per share being paid to shareholders on the register prior to that. Those who purchase shares on or after the ex-dividend date are not entitled to receive the dividend and so the price they pay reflects that.

Important dividend dates

As an investor, it’s important to keep track of the key dividend dates for any shares you invest in.

• Announcement date – as the name suggests, this is the date any dividend payments are announced by the company. This is normally on the same day as a company’s full year annual results. Before any dividends are paid out to shareholders, they must be approved by shareholders at the Annual General Meeting (AGM).
• Ex-dividend date – in order to qualify for the dividend payment, you must hold the shares at market close the day before the ex-dividend date. For UK shares, this is normally on a Thursday, which means investors need to hold the shares at market close on the Wednesday. If you sell the shares on or after the ex-dividend date, you still qualify for the dividend payment.
• Payment date – the date the company physically credits investors with the dividend payment. This is normally a number of weeks after the ex-dividend date.

Impact of dividends on share prices

Dividend payments represent money leaving the company’s balance sheet into the hands of shareholders. This effectively makes the company less valuable, which can cause its share price to fall.

For example, Company ABC plc is currently trading on the market for £10 per share and has recently announced a dividend of 50p per share. On the ex-dividend date (providing its market value hasn’t changed), you’d expect the share price to fall back to £9.50, all else being equal. This reflects the amount of money which is about to leave from the company.

Remember though, there are a number of different factors that can move share prices, so they won’t always perform as expected. Investors should take a long-term view (at least five years) when investing and a company’s dividend-paying credentials shouldn’t be the only reason it features in your portfolio.

All investments and any income they produce can fall as well as rise in value so clients could get back less than they invest.

What is a dividend yield?

A dividend yield measures the amount of income paid out to shareholders over a specific period of time.

Dividend yields are expressed as an annual percentage and are calculated by taking any income payments (usually over the last 12 months) divided by the current market value of the investment (dividend/price = dividend yield).

To use the same example from above. Company ABC plc would have a 5% dividend yield (50p/£10=5%).

A yield is an important metric for lots of investors, especially for those looking to secure an income in retirement. They can be a handy tool to help forecast the future cash you could expect to earn from your investments. Yields are variable and not a reliable indicator of future income.

Why companies pay dividends

Companies often have an agenda to keep their existing shareholders happy, while trying to attract new investors – dishing out cash to shareholders can help with this.

A strong track record for rewarding investors with dividend pay-outs usually bodes well for a company’s share price, attracts new investment and keeps existing investors satisfied.

Some companies might choose to retain any profits and re-invest back into the business, also known as ‘growth’ stocks. They tend to be younger, with more opportunities to grow and develop when compared to their more mature and well-known peers. Growth stocks look to reward investors through capital gains by growing their share price over time.

A company that boasts a robust track record of dividend payments can be a sign of a great business that has generated plenty of cash.

Take Coca-Cola as an example. It’s a dividend-paying machine. One that’s managed to grow its dividend for more than 50 years, and has attracted Warren Buffett as one of its largest shareholders.

While dividends are normally a good sign, companies with market-leading dividends could be vulnerable to share price drops if they cut or reduce their dividend. A company’s inability to pay out profits could raise red flags with investors as it could be a sign the company is in trouble. Sometimes, a high dividend yield can indicate the market doesn’t expect dividend payments to continue at their previous level.

Overseas dividends

These are broadly speaking, very much like UK dividends. They are generated in similar ways as we’ve mentioned above, either to reward shareholders, attract new ones or paying out excess capital.

They also have their yields calculated in the same way, of course being subject to a different currency, their share prices get affected by dividend announcements and they need shareholder approval at AGMs.

The difference comes from their taxation and the way they are paid. Generally, for UK brokers, they’ll receive the dividends in the listed country’s currency. For example, a US company will pay its dividend in dollars and the broker would convert this to pounds sterling before paying its clients. This could be subject to a charge that the client’s pay. This process can be more laboured if holding the shares directly.

Their tax treatment is also different as they are not exempt from tax if held within an ISA or SIPP, whilst UK assets normally would be, subject to your own circumstances. They are also typically levied additional taxes subject to the country the company is listed in.

Dividend tax

A dividend is a form of income so, unfortunately, you might have to pay tax on your income from dividends.

You don’t pay tax on dividend income that falls within your Personal Allowance (the amount of income you can earn each year without paying tax). Investors also have a dividend allowance of £1,000 per tax year.

The tax man will deduct tax on any dividend income above your allowances. How much tax will depend on where you sit on the income tax band spectrum. Tax rules can change and benefits depend on personal circumstances.

Information correct as at 02/11/2023.

You do not pay UK tax on dividends received from investments held in an ISA or SIPP (Self-Invested Personal Pension) as they’re tax-free accounts.

For any overseas dividends outside the UK, an additional tax may be applied known as withholding tax to any shareholder who resides in the UK regardless of the wrapper.

Generally, it’s a tax levied by an overseas government on dividends or income received by non-residents. For example, the US Government charges non-US residents’ withholding tax of 30% on any income received from US investments.

The UK government has double taxation agreements (DTAs) in place with many countries to reduce the amount of tax paid by UK residents. In these circumstances, it may be possible for investors to reclaim all or part of the withholding tax paid. They’d need to contact the relevant tax authorities to determine their requirements as these may vary from country to country.

One common example of a DTA is the W-8BEN form. This allows the amount of withholding tax to be reduced for any UK tax resident on income from US based investments.