What you need to know about dividends

Dividends are essentially excess profits the company has decided to distribute to their shareholders. Companies are not obligated to pay out dividends as they may decide to reinvest their profits back into the business. Otherwise they may not have been profitable enough to pay out any dividends. Established companies are more likely to pay out dividends than start-ups. The reason for this is that companies need to be consistently profitable to have the capacity to pay out dividends.

Please see below some terms associated with dividends which would be useful to know.

Record date:  This is an important date for dividends as it determines which shareholders are entitled to a dividend payment. Shareholders who are registered in the company’s record as at 5:00pm of the record date will be paid the dividend. As settlement is now T + 2, the stock needs to be purchased two days before record date. This is so the trade settles and the shareholder is registered on the company’s records on record date.

Ex Dividend Date: This date is one business date before the record date. To be entitled to the dividend, shareholders must buy the stock before the ex date. Purchases made on or after the ex date will not be eligible for the dividend. If shares are trading ex dividend, it means that if the investor buys shares within this period, they are not entitled to the dividend. In this instance, it would be the seller of the shares that would be entitled to the dividend. Usually on ex div date, the share price drops by the amount of the dividend as the market discounts the dividend from the stock price.

Cum Dividend: When shares are trading cum dividend it means if the investor buys shares within this period, they are entitled to the dividend.

Dividend Imputation: This is a tax credit to shareholders who have received dividends. As companies have already paid tax on profits, shareholders are able to obtain a tax credit to prevent double taxation of profits. Please see the link as we have previously written on this topic with calculation examples   https://fairmontequities.com/an-easy-guide-to-franking-credits/

The 45 Day Rule: To claim a franking tax offset you must hold the shares continuously for at least 45 days plus the day of purchase and the day of sale (or 90 days for certain preference shares). Small shareholders are exempt from this rule if they can show a franking credit entitlement below $5,000. This is approximately equivalent to receiving a fully frank dividend of $11,666. In a SMSF however there are no exemptions as the 45 holding day rule is applied to all shares regardless of the total value of franking credits.

Dividend Stripping: This is a trading strategy where investors buy a stock prior to ex-date (so they receive the dividend) and once the dividend is collected, they sell the stock. The reason investors do this is to obtain the dividend and franking credits and perhaps the capital gain. However as per the previous point, investor should be aware they need to hold the stock continuously for 45 days to be eligible for the franking credit unless the franking credit entitlement is below $5000.

Dividend Reinvestment Plan: Some companies offer shareholders a choice to receive their dividend as stock instead of cash. Usually the DRP offer of new shares is often at a discount to the market price of the stock. The benefit of DRPs is compounding as the shareholder’s position is increased by the addition of the new shares and new DRPs are continually calculated on the existing position plus the new DRP shares. Therefore, your position potentially can grow over if you forgo the cash dividend. The downside is if you sell your shares many years later, then you needed to have kept track of all the different purchase prices over time.

Dividend Yield: This is a ratio which shows how much the company pays out in dividend each year. This is expressed as a percentage of the current share price. Dividend yield is the expected yearly dividend divided by the current stock price.

A dividend yield of more than 5% would indicate the stock is a high yielding stock.

The top 20 highest dividend yielding stocks at the moment are listed below:

Lauren Hua is a private client adviser at Fairmont Equities.

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