Share Investing - Dividends
Dividends are the money a company pays to shareholders each year. In New Zealand companies tend to pay an interim dividend sometime around the middle of the year and a final dividend somewhere around the end. Many of the listed property companies pay dividends quarterly.
Dividends are generally expressed in cents per share.
In New Zealand dividends are classed as taxable income however they generally carry "Imputation Credits". This means the amount you receive has already had tax paid on it (usually at 30%) and you will only have to pay tax at your marginal rate. If your marginal rate is less than 30% then you may get even get a refund.
Dividends are sometimes overlooked as a source of income from investments. Call us on 07 578 3863 if you would like to discuss how you might be able to get a higher return than you are receiving from your bank and the risks associated with that.
If you are investing in the sharemarket you really should understand dividends and some of the ratios associated with them.
Dividend yield is one of the handy fundamental analysis tools we can use when scanning the stock market for good value stocks to buy. It simply measures the cash return an investor can expect in the form of dividends on an investment in any particular share. The dividend yield on a particular share is very easy to calculate, the formula to calculate dividend yield is:
Dividend Yield = Dividends per share (per annum) / Share price.
For example a company that pays 0.20 cents per annum in dividends at a share price of $2.00 would have a dividend yield of 10%. If the prices rises to $2.50 the yield to new buyers falls to 8%.
On their own changes in share prices do not change the amount of dividend a company pays.
Forecast Dividend Yield
Investors should be careful when looking at dividend yield alone, as a high dividend yield can mean that the company's share price is low because the market doesn't expect it to be able to continue to pay out the same level of dividends. The figures reported in Newspapers are usually historical dividend yields. Of course it isn't the historical dividend yield or dividends that a company has paid in the past that is important, but rather, what it is likely to pay in the future or the forecast dividend yield. Analysts spend much of their time trying to forecast company dividends. One method of valuing a company and so working out its theoretical fair value share price is to calculate its net present value, the current value of its future dividend stream. If we take all the dividends expected to be earned in the future and convert it back into todays money it gives us a theoretical value and so a fair value share price.
At Bay Financial Partners we have access to external analysts who analyse companes and forecast dividend yields for a living. Call us on 07 578 3863 to compare their forecasts with yours before you decide to invest.
Dividend Pay Out Ratio
Dividend pay out ratio is the proportion of profits a company pays out in dividends. A company that is in a growth phase may not pay any dividends as it is reinvesting all its profits to help it grow so its payout ration might be xero. A company in a mature phase may pay out most or even all of its profits so its payout ratio may be a hundred percent. Generally companys in New Zealand tend to pay out somewhere between 40 and 60 percent of dividends.
Dividend cover is how many times profit will pay the dividend. Dividend cover is the inverse of the payout ratio. If a company's pay out ratio is 50%, a years profits will cover two years worth of dividends.
Investors hate it when a company reduces its dividend, and hate it even more if it doesn't pay a dividend at all so many companies will keep money in reserve so that if they have a bad year (or two) with low profits they can still pay out the same amount in cents per share.
Why Interest Rates affect Share Prices
There are three main reasons changes in interest rates affect share prices, all other things being equal;
- Most companies have some debt or borrowings so if interest rates go up they will they will pay more interest which will reduce their profits.
- Rising interest rates can indicate rising inflation and that will affect different companies in different ways depending on the business they are in.
- Investors are always looking for the highest risk weighted return, if interest rates go up it makes shares less attractive so share price will tend to fall which pushes the dividend yield up to the point where the market thinks the risk weighted return is back in balance with interest rates.
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