Why Dividends Matter?

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Australian Economy

We all, by now, understand that the word ‘dividend’ in equity parlance comes from the Latin word ‘dividendum’ which means ‘things to be divided’; and a dividend particularly, refers to a reward that is made by the company to its shareholders, usually as a distribution of profits. Whenever the company earns profit or surplus then the company has two choices i.e., either retain the earnings for business expansion or pay a portion of the profit as a dividend to shareholders. Dividends can be issued in various forms like cash dividends and stock dividends. Particularly, stock dividends are generally offered in the form of additional shares to the shareholders, while cash dividends are paid in the form of cash.

Generally, profitable companies pay dividends to reward their shareholders. However, it is not necessary to pay the dividends on a regular basis to shareholders. If company feels that its own growth opportunities need priority, then the company can keep the profits and divert them to the business expansion plan. For companies having a strong foothold both in terms of performance and market share, profits may be distributed as dividends and some part of cash might be retained to fund business activity and handle contingent liabilities. On the other hand, emerging or nascent companies intend to reinvest their earnings for expansion and growth, setting their trajectories for future. Further, if a company has incurred losses during the year but has a healthy cash reserve, then the company can still pay dividends from its cash reserves. Usually, established companies tend to provide regular dividends to reward their loyal shareholders, as these add support to the profit that the companies may project on a paper. Another key thing is that dividends serve as a tax-efficient means of obtaining income.

Therefore, most of the investors love to see the dividend yield of the company on a regular basis. For calculation purposes, dividend yield is the annual dividend income per share divided by the current market price of the share. However, it is very difficult to choose dividend paying stocks just by looking at the yields simply. In that case, we should find the combination of high dividend paying stocks and strong businesses with a good growth potential. Let’s understand with an example, Caltex Australia (CTX) has an annual dividend of 121 cents per share and closing share price as at March 14, 2018 was $32.53. CTX’s dividend yield is therefore 3.7%. Whereas, Scentre Group (ASX: SCG) has an annual dividend of about 21.73 cents per share, and a closing share price at March 14, 2018 of $3.89 makes the dividend yield to be 5.49%. Thus, just a dividend yield might not be sufficient enough to take a call on what kind of stock to invest in. So, we need to familiarize ourselves with the company’s strategic direction and ambition, as well as its financial performance and balance sheet position. We need to review the latest annual report in detail, including its management discussion and analysis, which offers insight to the company. Investors thus need to look at dividend payment as a sign that a company is flourishing financially at the back of continued earnings, and this increases interest in the stock.

Yet another key aspect to look at is Dividend coverage ratio that reflects that how much of a company’s profit is getting paid to shareholders as dividends. For example, if a company earns $1.00 per share and pays a $0.85 annual dividend, its pay-out ratio is 85%. Generally, strong dividend stocks are generally long-term performance achievers with lower risk and volatility, than non-dividend paying stocks. These dividends are important in the creation of wealth for individuals or groups. However, a recent case of Telstra (TLS) demonstrates that dividend yield is also valued with respect to the group’s overall performance and any challenge that a company might be facing from a macro viewpoint.

Having said all this, one has to agree that Dividends matter to investors as they vouch for a more disciplined approach in terms of company’s investment decision-making. In fact, the companies that pay dividends are sometimes found to be more efficient in their use of capital as compared to companies which do not pay dividends. Eventually, sharing a portion of profitability in the form of a dividend could help investor witness a sigh of relief, especially during challenging phases and when market volatility hovers over the stock performance.

Meanwhile, the news that is doing the rounds in Australia that the Labor party, if elected, is all set to scrap tax refunds on dividends paid to retirees and pensioners, has led to a wave of uneasiness among shareholders. While the intent is to ease the deficit and fund other programs, the move can play havoc on high yielding ASX stocks. Leaving this aside, investors are always on the hunt of good dividend players for a steady stream of income.


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