Company share dividends are, for many investors, a vital part of the stock market landscape.
For investors seeking an income, as part of a retirement planning strategy for example, dividends play an important role.
Having experienced a significant wobble during the darkest days of the Covid-19 crisis in 2020, dividends have rebounded in the interim and payouts now stand at, or near, pre-pandemic highs.
Here’s a look at what dividends are, why companies pay them, and the best ways for would-be investors to incorporate them into an investment strategy.
Remember that investment is speculative and your capital is at risk. You may not get back some or all of your money. No part of this article should be considered advice.
What is a dividend?
A dividend is a distribution, usually in cash, paid by a company to its shareholders. Payments are met out of a company’s earnings in a given year.
Dividends tend to be paid every six months. But it’s also possible for them to be paid annually, or on the quarter, and they tend to be made on a ‘per share’ basis. For example, the owner of 100 shares in a business that announces a 5p dividend would receive £5.
As well as regular dividends, payments can also be made on a ‘special basis’. These are usually one-off payments, such as when a company has completed a major transaction. This could be when a business sells off a particular division and, as part of the move, decides to return some of the sale’s proceeds to shareholders.
Stock dividends are less common than cash dividends. Instead of a cash payment, this is where a company issues extra shares to its shareholders. For example, a company issuing a 2% stock dividend means a shareholder would receive an extra two shares in the business for every 100 already held.
A ‘scrip’ dividend, meanwhile, is where a company offers to pay a stock dividend instead of cash. The company issuing the scrip dividend then gives shareholders a choice: cash or extra shares.
Mark Peden, manager of the Aegon Global Equity Income fund, expects dividends to form a bigger proportion of total returns for investors this year than at any time in the past decade: “Dividends are an important element of long-term equity returns, forming about one third of returns since 1940. This becomes even more important when capital returns are more muted.
“We expect dividends to be a greater proportion of total returns in the current environment than they were through the past decade, when capital returns dominated.”
Why do companies pay dividends?
Paying a dividend enables a company to share its profits with shareholders. This is both a mark of thanks for ongoing support and also an incentive for shareholders to continue holding their shares.
Investors tend to regard consistent dividends as a sign of a company’s strength and that a management team has positive expectations around future earnings growth. This in turn makes a company more attractive to investors, which in turn helps to drive up the company’s share price.
Companies that can show a consistent and rising track record in terms of their dividend payouts are of particular interest to income seekers, from individual retirees, to charities and professional investment managers running corporate pension funds.
Not everyone in investment circles is a fan of dividends and certainly not where payouts are seen as excessive. Some professional investors believe management boards preoccupy themselves too much with paying dividends as a means of keeping shareholders on side.
Which companies pay dividends?
Companies are not obliged to pay dividends and plenty of successful businesses refrain from doing so.
Of the companies that do, the amount distributed in dividends might range from a large proportion of earnings to a relatively small fraction. For example, a start-up business potentially needs to use most of its earnings to build products, hire staff and expand. Paying dividends at this stage of its maturity might be regarded as a poor use of available cash.
Companies with a strong track record of paying dividends tend to be found in specific industrial sectors within the stock market. These include utilities, commodities, energy and healthcare - solid businesses with well-defined trading patterns and large customer bases, leading to consistency in their profits.
Some companies pride themselves on their consistent approach to paying healthy dividends. That said, there is no guarantee that, just because a company boasts a strong track record on paying dividends that it will continue to do so.
For example, a company planning an acquisition or other investment that requires a large amount of cash might need to alter its dividend strategy.
How much do companies pay in dividends?
Total dividends from UK-listed companies hit £37 billion for the second quarter of this year alone, according to Link, the fund administration group. About a quarter of this came from the mining sector.
Companies worldwide made dividend payments worth an all-time high of £1.1 trillion to shareholders in 2021, according to investment firm Janus Henderson.
This figure was a dramatic reverse compared with 2020 when companies were forced to cut or suspend their dividend payments during the Covid-19 pandemic.
During that period, nearly 500 companies listed on the London Stock Exchange suspended dividend payments, including nearly half of those from the FTSE 100 index. Dividend payments to shareholders in the UK fell by 44%.
Since then, nine out of 10 companies have bounced back either maintaining or raising their dividends from previous levels. Last year, dividends from UK, European and Australian markets grew the fastest compared with 2020, thanks to a recovery in the mining and banking sectors.
What does ‘dividend yield’ mean?
When calculating the potential income from a share, investors look at a company’s dividend yield. This reveals how much a company pays out in dividends relative to its current share price.
For example, if ABC plc’s shares trade at £50 and the company pays an annual dividend of £2 per share, the dividend yield is 4%.
In comparison, if rival business XYZ plc’s shares trade at £200 and its annual dividend is £3 per share, its dividend yield is much lower at 1.5%, even though investors receive a larger amount per share.
What is a ‘good’ dividend yield?
There’s no one-size-fits-all answer to this question. But it’s important, when scrutinising a company’s prospects, to look at more than just the yield figure. Other factors to consider include the trajectory of a company’s share price, its earnings per share, and the price-to-earnings (P/E) ratio.
The latter is a way of measuring how highly investors value the earnings that a company produces.
Two similar size companies operating in the same sector might be expected to have similar dividend yields. If one is a lot higher than the other, this could be a sign that it’s an attractive investment. Alternatively, it could be a sign of trouble - a sharply falling share price, for example, which is rarely a good sign for investors.
Generally speaking, investors need to be wary of high and unsustainable dividends. Yields between 2% and 5% are considered strong, and anything above this can indicate a great buy - but may also come with risks attached.
If your focus is on receiving dividend payments from the UK’s leading companies, use the overall yield on the FTSE 100 index - currently around 3.8% at the time of writing (13 September) - for comparison purposes and as a benchmark for individual businesses.
How are payouts determined?
Companies map out their dividend policy over time. Having acquired a recommendation on the size of dividend from a company’s management board, the amount a business proposes to pay in dividends is then voted on by shareholders.
Paying out dividends to potentially hundreds of thousands of shareholders is a major piece of administration. Key elements in the process include:
- Declaration date. A company formally announces it is going to pay a dividend. At the same time, it will disclose the ‘ex-dividend’ date and the payment date.
- Ex-dividend date. This is the day where potential buyers of the company’s shares stop being eligible for the upcoming dividend payment. It’s possible to continue buying shares after this date, but no dividend will be received. If you sell shares before the ‘ex-date’ you don’t receive the dividend. But if you wait until after the ex-date and then sell, you will.
- Record date. Often the day after the ex-dividend date when a company determines which of its shareholders are eligible to receive dividends.
- Payment date. The day dividend payments are made to shareholders.
How are dividends taxed?
You do not pay tax on any dividend income that falls within your personal allowance. This is the amount of income you can earn each year without paying tax.
You also receive a dividend allowance each year and only pay tax on any dividend income above this amount. The allowance for the 2022/23 tax year is £2,000. Tax is not paid on dividends from shares held within a product such as a stocks and shares individual savings account.
How much tax you pay on dividends above the dividend allowance depends on your income tax band according to the table below.
Table 1: Dividend tax rates
| Income tax band | Dividend tax rate 2022/23 |
| Basic rate | 8.75% |
| Higher rate | 33.75% |
| Additional rate | 39.35% |
For retail investors, there are two main ways of incorporating dividends into your investment portfolio: by buying shares of dividend-paying companies , or buying into specialist funds which have exposure to a wide basket of dividend-paying shares.
Either way, the easiest way to do this is via an investment trading platform.
Dividend-paying shares
When looking at reliable dividend-paying firms, Aegon Asset Management’s Mark Peden says the high quality companies are those that generate consistent returns and have strong balance sheets: “Quality means companies that generate good, consistent returns on equity and have strong balance sheets which, in practice, means relatively low levels of net debt.
“The trick is to find companies that can pay dividends above the market, are well covered by earnings and likely to grow over time. These metrics should be steady over time, rather than fluctuating wildly from year to year.
“Companies with high levels of debt and excessively high dividend pay-out ratios are much more vulnerable to high inflation, rate rises and slowing economic activity. Dividend cuts are often the result.”
For investors looking to add dividend-paying shares to their portfolio, Jack Byerley, deputy portfolio manager at wealth manager WH Ireland, suggests insurer Legal & General: “It is a well-diversified company with an impressive management team that has been able to deliver consistent earnings growth, yet continues to be overlooked by the market.
“Concerns about the amount of market-sensitive high-yield debt it holds and investment in social housing have held the stock back this year. But now yielding around 8%, the company can offer investors a strong dividend and steady growth at an attractive valuation.”
Adrian Clayton at investment group Ravenscroft also favours the financial sector: “Investors should consider Duke Royalty, a specialist provider of business finance, for its superior dividend yield. The company is a pioneer in offering corporate royalty finance in the UK and Europe and is the only London listed company in this space.
“Duke offers investors a dividend per share of 2.8p, which equates to a dividend yield of 8%, which is well covered by annualised free cash flow.”
According to Mr Clayton another favoured play is insurer Aviva: “The share price looks to have found a base post-pandemic and is now building momentum. We see this as a direct result of the company’s strong solvency ratio, its robust cash generation and an attractive valuation in an already cheap sector. Aviva offers a generous dividend that looks increasingly secure, which we estimate will approach 6% for the coming year.”
Away from the financial sector, Ian Brady, chief investment officer at WH Ireland, highlights the appeal of Unliever: “Following a couple of years out of favour, the tide seems to be turning for the company.
“Firstly, Unilever derives more revenue from emerging markets than many of its peers and this will become more of a tailwind compared with the headwind that it’s been of late. Secondly, the company was able to demonstrate very strong pricing power in the second quarter of 2022, a great attribute in the current environment. Thirdly, the company has given activist investor Nelson Peltz a seat on the board and he is seen as a genuine force for good.”
Brady says all this combined means Unilever should be looking at a compound dividend growth figure of more than 5% over the next two years from a healthy starting yield of 3.7%.
Funds worth considering
Income funds aim to generate a steady, preferably growing, level of income through holdings in dividend-paying companies.
Richard Morley, investment manager at wealth manager Brewin Dolphin, says retail investors could consider the Evenlode Income Fund: “The fund invests in a very focused portfolio of approximately 20 to 30 companies. Although the dividend yield is under 3%, we like the investment approach that concentrates on resilient companies, such as Unilever and Diageo, with strong and growing cashflows and product ranges which are very difficult to replicate.
“In these current challenging economic conditions, it’s these sorts of businesses which should prove to be valuable for the portfolio.”
For investors with an eye to overseas, Mr Morley suggests the BNY Mellon US Equity Income Fund: “One of the challenges of investing in the US market is the lack of dividends paid by American companies. This fund looks for companies paying a dividend yield at least 50% higher than the influential S&P 500 stock index.
“The strategy has worked well in the last 12 months, with the fund up 26% between September 2021 and now.”
Investment trust options
Investment trusts are similar to funds in that they pool money from investors to buy a basket of shares.
The Association of Investment Companies publishes a list of ‘dividend heroes’ that have consistently increased their dividends for at least 20 years. Among these, seven have increased their dividends over 50 years or longer. They are:
- City of London Investment Trust
- Bankers Investment Trust
- Alliance Trust
- Caledonia Investments
- Global Smaller Companies
- F&C Investment Trust
- Brunner Investment Trust.
