If you are a seasoned investor in the stock market it is likely that you are familiar with dividends. However, it is important to make sure you are across both the advantages of dividends and how they work, to ensure that you are maximising you returns. To learn more, continue reading the article below.
What are dividends?
Dividends refer to the portion of a company’s profit that is paid out to shareholders typically once or twice a year, and is passive income generated from holding particular shares. The amount paid is calculated based and paid on a per share basis. Whether a company pays dividends is often a major factor for investors deciding which companies to invest in. However, a company is not obliged to pay dividends and many investors still choose to invest in companies that do not. Instead of paying a dividend, a company may choose to use these profits to continue growing the company, leading to more long-term growth and an increase in their share value.
What are the benefits of dividends?
Dividends provide investors with many benefits as the can significantly increase a shareholder’s total returns as they both provide a regular source of income that can be realised as cash or can be reinvested to boost future returns.
What are the mechanics of dividends?
First, a company will make a declaration which is an announcement to the market that they intend to pay a dividends and what the value of that dividend will be and will also be sent directly to shareholders. Within this announcement, a company will outline an ‘ex dividend’ date. This means that in order for shareholders to be paid the dividend, they must have held shares on the ex-dividend date. If investors were not shareholders before said date, they will not receive the dividend. The payment date, which is pretty self-explanatory, is the date the company will pay the dividend to shareholders.
Franked, partially franked and unfranked
Dividends can either be fully franked, partially franked or unfranked. When a dividend is franked, it means that the company has already paid the tax on these profits, and therefore the tax payable on the income earned by shareholders can be reduced or eliminated. If it has been partially franked, the company has only paid a portion of tax and therefore shareholders will have to pay the remaining amount to the ATO.
Shareholders can use the franking credits attached to their dividends to receive a tax rebate which will be contingent on the marginal tax rate of each investor. Shareholders in a high tax bracket may not be entitled to a refund or the franking credit. Conversely, lower income earners may be able to receive a full amount of the franking credit as a refund.
The dividend yield is an important concept to understand as it represents the value of the dividend in relation to the share price which shows the return on investment. However, it should be noted this is a guide only and investors can take into consideration a range of other factors such as the company’s overall performance, potential future growth and other contingencies that may mean it is a favourable investment.
What is a dividend reinvestment plan?
This is something that not all companies offer but refers to a scheme in place whereby shareholders who will be receiving dividends have the opportunity to either receive the profit as a cash payment or can choose to reinvest in and receive additional shares in the company. Some companies may also choose to offer these shares at a discounted rate to their market rate in order to attract shareholders to reinvest and continue growing the company.
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