The top 10 things you need to know about dividends

The world of dividends can become confusing for the investor if they are not familiar with the all jargon. These are the top 10 questions commonly asked about dividends.

  1. Why do companies pay dividends?

Companies decide to pay dividends to investors out of their excess earnings as a way to reward them. Companies need to be making money to be able to pay dividends. So generally speaking, firms that can pay dividends are in a financial stable position.

  1. Are dividends compulsory for companies?

No, dividend payouts are not mandatory for companies. Some growth companies may decide to not pay dividends and use the excess funds to grow the business.

  1. What is the difference between a franked and unfranked dividend?

A franked dividend is a dividend with a tax credit. The company has already paid tax and dividends are paid from after tax earnings. This means the investor can receive a tax concession from holding the stock. An unfranked dividend means the company has not paid tax in Australia and therefore the stock owner must pay tax on this.

  1. Why do some companies decide to pay frank dividends and other unfranked dividends?

Some companies do not pay much company tax as they are able to use deductions to offset their income. Therefore they are unable to pass on these franked credits as they have not paid tax themselves.

     5.When do I need to buy the stock to receive the dividend?

You need to purchase the stock one day or more before the ex-dividend date to receive the dividend. If you purchase the stock on the ex-dividend date then you will not be entitled to the dividend.

     6.Why does the share price of the stock drop on ex-dividend date?

Once the stock trades ex-dividend, this means the buyer will not receive the dividend. Therefore the share price of the stock drops by the value of the dividend.

  1. What is a dividend reinvestment plan?

Instead of receiving the dividend payment in cash, shareholders can opt to have some or all of this paid in new shares. Over time the shareholding is increased automatically as more dividends are reinvested in shares. This program is not offered with all companies, it is at the discretion of each firm.

  1. What is a dividend yield and why is it important?

The dividend yield represents the percentage of the company’s dividend compared to its share price. A higher dividend yield may signify higher income from that stock. A dividend yield over 6% is considered high. This yield is important to investors who rely on their investment portfolio for income. Therefore they will look for stocks with higher dividend income to fund their living expenses.

  1. What is the difference between cum-dividend and ex-dividend

If you own the stock during the cum-dividend period, then you are entitled to the dividend.

If the stock is trading ex-dividend, it means that if you buy the dividend during this time, then you will not be entitled to the dividend.

  1. When can I sell the stock and still receive my dividend?

You can sell your position on or after the ex-dividend date and still receive your dividend.

Lauren Hua is a private client adviser at Fairmont Equities.

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