Dividend investing – the basics and jargon busting

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CMC Invest

08 March 2023

Key points

  • If you’re putting money to work for the long term, it’s often attractive to have investments that also offer income.
  • Dividend-paying stocks can provide this income in addition to appreciating in value over time, making them a popular choice among investors.
  • Knowing the jargon around dividends can help you understand how you can become entitled to them and when you can expect to be paid.

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When you invest, your capital is at risk.

Important: This article is for general guidance purposes only and should not be considered investment advice. If you are unsure about the suitability of an investment, please seek out advice. When you invest, your capital is at risk. Tax treatment will depend on your individual circumstances and could potentially change in the future.

For many of us with long-term investing plans, finding assets that provide income is appealing. Regular payments generated by the securities we’ve purchased can make it easier to put cash away for 5+ years.

Lots of investors actively seek out stocks that pay dividends, sometimes as part of such an income investing strategy. In theory, the value of these stocks can appreciate over time while also providing investors with a regular cash payment.

This sounds attractive, but there are some risks and considerations involved, which we’ve covered here. For now, let’s break down what a dividend is and some of the terminology you need to familiarise yourself with.

“A dividend is a payment that’s distributed to the shareholders of a company, usually taken from the company’s profits.”

What is a dividend?

Dividends are payments distributed to the shareholders of a company, usually taken from the company’s profits. They are often framed as both a reward for continuing to hold that company's stock and as an incentive for you to hold on to that stock for the long term. This doesn’t mean, however, that you have to be a long-term investor to be eligible for a dividend. You also don’t have to hold the stock after the dividend is paid if that’s your preference.

Dividends can be paid on a yearly, bi-annual, quarterly or even monthly basis. Payments are made per share – so the overall payment you receive will depend on how many shares you own in total.

Typically, dividends are paid out in the form of cash and it’s up to you what you do with this money. Many investors choose to reinvest their dividends to buy more shares instead of taking the cash as income.

"Some firms choose to pay very low dividends, retaining most of their profit and reinvesting it in the growth of the company."

How much can you be paid in dividends?

This is an interesting question that’s determined by a company’s board of directors, who will consider financial performance and come to a decision on what can be paid out to shareholders.

Some firms choose to pay very low dividends, retaining most of their profit and reinvesting it in the growth of the company. Others choose to pay a higher dividend so that they encourage new investment since they may be in slow growth industries, such as consumer staples or real estate.

To give you some examples, Apple paid a quarterly dividend of $0.23 per share in Q4 2022, while Microsoft paid $0.68 per share and General Motors paid $0.09.

The annual dividend amount divided by the purchase price of the stock is called the dividend yield. A stock paying £0.20 in dividends annually that was bought for £20, for example, has a dividend yield of 1%.

During the 2010s, the dividend yield of the S&P 500 averaged just under 2% annually. Since 2020, the index has seen a dividend yield slightly below this.

Jargon busting

There’s a fair amount of jargon when it comes to dividend investing. Understanding this will help you understand when stocks are scheduled to pay out dividends and what you must do to be entitled to them. Here, we’ve listed out the main terms to look for and explained what they mean:

  • Dividend yield

  • Dividend history

  • Pay-out ratio

  • Dividend declaration dates

  • Ex-dividend date

  • Dividend payment date

  • DRIP stocks

Dividend yield

As previously noted, the dividend yield is a calculation of the value of the dividends a company pays out each year in relation to its stock price. This figure is presented as a percentage. It’s a simple calculation of the annual dividends paid out by the company divided by its price per share.

As a result of this calculation, a stock’s dividend yield increases as the value of its shares decrease and lowers when the share price increases – providing the amount it’s paying out as a dividend remains the same. Because of this, it’s common to see well-known, continuously expanding companies offering low dividend yields.

Dividend history

When searching for dividend-paying stocks, investors will want to choose stable and reliable companies – after all, if it’s the dividend you’re after, you want to make sure the chances of being paid this are high.

This often comes down to finding companies with a good record of paying their shareholders dividends on a consistent basis – i.e., their dividend history.

You may also want to check whether a company has raised its dividends for several years running. If so, it gives a good indication that a company has no immediate financial difficulty. Often, if a company is experiencing difficulty, it will “cut” its dividend so that it has money on hand to support the business.

Dividend pay-out ratio

In simple terms, this is the percentage of a company’s net income that’s paid out via dividends.

It can be used to quickly assess how much of its profits are being reinvested into the company and how much are being paid out to shareholders.

Declaration dates

The declaration date is when a company’s board of directors announce what the next dividend amount will be. On this date, the board of directors will also announce the ex-dividend date.

Ex-dividend date

The ex-dividend date is the date that determines whether an investor is entitled to a company’s next dividend payment. Shareholders as of this date will receive a distribution from the company.

If a company sets the ex-dividend date for 12 August and an investor buys 200 shares of the company before that date, they will be entitled to receive the next dividend in accordance with the number of shares they’ve bought. However, if they invest after the ex-dividend date, they won't be entitled to the dividend – even if it has yet to be paid out.

Payment date

The payment date is when the dividend is paid into the investors’ brokerage accounts or when cheques are issued. This date can be up to one month after the ex-dividend date, but is usually within two to three weeks.

DRIP stocks

A dividend reinvestment plan (DRIP) is an option that some brokers offer to their clients that allows them to automatically reinvest the dividends paid to them by purchasing additional shares of the same stock.

Let’s say you have a DRIP account set up with a broker and were paid quarterly dividends worth £30 by one of the companies you’re invested in. Instead of that payment being allocated as cash into your brokerage account, it would be used to purchase additional shares of the same company.

Some exchange-traded funds (ETFs) take a similar approach, automatically reinvesting dividend payments so that investors can take advantage of compounding.

Taxing dividends

For the UK tax year 2022/23, dividends are tax-free for the first £2,000 earned. Any income generated after this amount is subject to the same rate of taxation as your income tax band. This amount will be halved for tax year 2023/24.

You can reduce your tax liability by utilising a wrapper, such as a stocks & shares ISA, which allows you to invest up to £20,000 each year, tax-free.

Note: tax treatment will depend on your individual circumstances and could potentially change in the future.

Are dividends right for you?

Investors looking to generate income from their portfolios will often turn to dividend-paying stocks. While they are popular securities, they aren’t the only investments you can make if income is your focus.

As with any investment, they aren’t without their risks. If you want to read more about the pros and cons of dividend investing, we’ve put together a guide here.

Capital at risk.