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How dividends work
Dividend investing is a popular strategy for generating passive income and growing your wealth over time. But to maximize the potential returns from your dividend investments, it's important to understand the key dates in the dividend process. In this article, we'll explain the different dates you need to know about, and how they can impact your dividend income. We'll also provide some tips on how to track these dates and manage your investments accordingly. Whether you're a beginner or an experienced dividend investor, this article will provide valuable information to help you get the most out of your dividend investments.
Big ideas
- There are 4 main dates to know about, but the most important are the ex-dividend date, which is the last day to qualify for the dividend and the payment date, when the money is paid out to you.
- The dividend yield tells you what you can expect to earn per share, and the payout ratio indicates how sustainable those earnings might be.
How do stock dividends work?
Dividends are cash payments that a company will pay to its shareholders at regular intervals (usually quarterly). They are paid out of the company's earnings.
Dividends help companies attract investors and provide you, as an investor, with regular income. Reinvesting the payment received even allows you to purchase more stock in companies that you own for free!
Dividends help companies attract investors and provide you, as an investor, with regular income. Reinvesting the payment received even allows you to purchase more stock in companies that you own for free!
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The dates
Companies pay dividends regularly, most often quarterly, alongside earnings reports. Here are four important dates you should add to your calendar.
1. Declaration date
The declaration date is when the company announces it is paying its dividend to investors.
On the declaration date, a declaration statement is released which includes the size of the dividend payment. It’s on this date that you learn how much you get paid!
Note
The declaration date can be an important day for the share price because the size of the dividend is one way management expresses its confidence (or lack thereof) in the company's future performance.
If the company increases the size of its dividend, then that shows management is confident enough in future earnings growth to give more of it away to shareholders. If a firm cuts its dividend, it's often a bad omen. That doesn’t have to be the case, so you need to look at each situation on its own merit.
Some other things to be found in the declaration statement are:
Some other things to be found in the declaration statement are:
- The record date
- The payment date
2. Ex-dividend date
The ex-dividend date is the date by which you must own the stock to receive the next scheduled payment. In the City of London, you’ll hear about share prices falling because they went ‘Ex-Div.’
If you purchased a stock before the ex-dividend date, you are entitled to the next payment. Likewise, if you bought the stock on or after the ex-dividend date you are NOT eligible for this payment and the seller will keep it.
That’s why the share price drops when it goes Ex-Div. The price is adjusting for the fact that the shares no longer include an entitlement to receive the coming dividend payment.
That’s why the share price drops when it goes Ex-Div. The price is adjusting for the fact that the shares no longer include an entitlement to receive the coming dividend payment.
3. Record date
The record date (aka. date of record) is similar to the ex-dividend date. You must be on the company's books as a shareholder (i.e. there is a record of you owning the stock) by this date, in order to receive the dividend payment.
This is the date that the company will pay the dividend to its shareholders. The company will send you the money, and if you own the stock via Trading 212, there will be a popup in the app to show you received it, normally a day or two later.
Dividend investing formulas
Next are the important ratios to know when analysing which dividend stock to buy.
1. Dividend yield
The dividend yield of a stock is a company's total payments to shareholders for the year expressed as a percentage of its current stock price.
Dividend Yield = (Total Dividend / Stock Price) x 100
Using this formula, you can work out the dividend yield of a stock.
If company A trades at $120 and its dividend per share is $6 annually, to work out the dividend yield, the dividend yield calculation is as follows:
If company A trades at $120 and its dividend per share is $6 annually, to work out the dividend yield, the dividend yield calculation is as follows:
6 / 120 = 0.05
0.05 x 100 = 5
Dividend Yield = 5%
0.05 x 100 = 5
Dividend Yield = 5%
Dividend yields will change over time. If the company decides to increase its dividend, then the yield goes up, and vice versa. The dividend yield also moves with the share price. When the price of the stock drops, then the dividend yield goes up. Let’s go back to the same example to demonstrate.
Company A’s shares are now trading at $100 instead of $120, but the payout is unchanged at $6.
Company A’s shares are now trading at $100 instead of $120, but the payout is unchanged at $6.
6 / 100 = 0.06
0.06 x 100 = 6
Dividend yield = 6%
0.06 x 100 = 6
Dividend yield = 6%
With the same payout in dollars ($6), company A has a dividend yield of 6% when the share price is $100, which is more than the dividend yield of 5% when the share price is $120.
The benefit of a high dividend yield is obvious, it means you are getting paid more per stock that you own. But there can be some drawbacks.
If a company has a high dividend yield, it means it is choosing to give away its earnings to shareholders instead of investing them in R&D or expansion. Over time this will limit the company’s growth potential.
There is also another big caveat to a high dividend yield, it may not be sustainable. You don’t want to buy a stock for its great yield, only for management to cut the dividend to something more affordable.
The benefit of a high dividend yield is obvious, it means you are getting paid more per stock that you own. But there can be some drawbacks.
If a company has a high dividend yield, it means it is choosing to give away its earnings to shareholders instead of investing them in R&D or expansion. Over time this will limit the company’s growth potential.
There is also another big caveat to a high dividend yield, it may not be sustainable. You don’t want to buy a stock for its great yield, only for management to cut the dividend to something more affordable.
2. Dividend payment ratio
Another way to think of a dividend is as a cost to the company offering it. If a company starts earning less income, the prudent thing for management to do is cut costs, one of which is the dividend. The problem is that management won’t always do the prudent thing right away.
This is where the dividend payment ratio (DPR) comes in. The DPR is the percentage of a company's earnings that it pays out to shareholders in dividends. Working out the DPR of a company allows you to see how sustainable the dividend payments are.
Payout Ratio = dividends per share (DPS) / earnings per share (EPS)
Example
If company B has a DPS of $4 and an EPS of $2 then their payout ratio would be 50%.
Investors prefer lower DPRs because it means there is a lower risk that the dividend eventually gets cut and a better chance that it will consistently grow over time. In other words, the higher the payout ratio the less of a safety net there is for a company's earnings. One bad quarter could jeopardise the dividend.
Rule of thumb - invest when the payout ratio is below 50%. This shows that the company is reinvesting more of its profits than it is paying out, laying the groundwork for future earnings growth and dividend growth.
Rule of thumb - invest when the payout ratio is below 50%. This shows that the company is reinvesting more of its profits than it is paying out, laying the groundwork for future earnings growth and dividend growth.
Example dividend stock investment
Here is an example of what happens when you own shares of Apple with Trading 212.
Before you invest, you want to see what the dividend yield is. This can be seen under the description of the company in the Trading 212 app.
Before you invest, you want to see what the dividend yield is. This can be seen under the description of the company in the Trading 212 app.
Key ratios / Dividend yield
Once you own shares of Apple and receive a dividend payout, the app confirmation will include the ‘date received’ and the Ex-div date, typically a week before the payment date.
Dividend payment confirmation
Recap
The main dates to know are the declaration date, ex-div date, payment date, and record date. The declaration date is when the company announces the dividend, the ex-div date is when the stock goes ex-dividend, and the payment date is when the payment is made.
The dividend yield is a key metric for investors, as it indicates how much income they can expect to receive from their investment. The payout ratio is also important, as it tells investors how much of a company's earnings are being paid out in dividends.
The dividend yield is a key metric for investors, as it indicates how much income they can expect to receive from their investment. The payout ratio is also important, as it tells investors how much of a company's earnings are being paid out in dividends.
