What are dividends? Why are they important to us?

What are dividends? Why do
companies pay them?

Companies that earn a net profit can do a number of things: pay some of that profit out to shareholders, reinvest it in the business, reduce debt or repurchase shares.

When a portion of the net profits is paid out to shareholders, the payment is known as a dividend. In the UK, dividends are usually paid twice per year.

Will I receive dividends?

Before a company can pay dividends to shareholders, it has to go through a legal and regulatory procedure. Dividends must be approved by the company's Board of Directors each time they are paid.

There are four important dates to remember regarding dividends. As an investor, you need to know what these dates represent as they determine whether you are entitled to receive a dividend or not:

  • The declaration date

  • The dividend record date

  • The ex-dividend date

  • The payment date

What Are Dividends on the record date?

The dividend record date is the date on which a company reviews its records to determine exactly who its shareholders are - an investor must be a "holder of record" in order to receive a dividend payout.

Click Here for an example.

What are dividends 'ex-dividend' date?

Before announcing a dividend, and in consultation with the London Stock Exchange, the company will set a date on which shares will be sold without entitlement to the dividend - known as going 'ex-dividend'. Before that date the shares are said to be 'cum-dividend', i.e. they have entitlement to the dividend.

The ex-dividend date of a share is the single most important date for dividend investors. To receive the upcoming dividend, an investor must purchase the shares prior to the ex-dividend date.

Anyone who buys the share before the ex-dividend date is therefore entitled to receive the dividend recently announced. If you purchase on or after that date then the dividend most recently announced is not payable to you but to the previous owner.

Click Here for an example.

What are dividends payment date?

The declared dividend will actually be paid out on the payment date to the shareholders.

To receive the dividend, your name must be on the share register on the relevant dividend record date. The dividend is only paid to shareholders for each share, so the amount you receive depends on the number of shares you own at the dividend record date.

If the shares are sold before the ex-dividend date or purchased after it, you will not be entitled to that dividend.

Click Here for an example.

Why do companies pay dividends?

Companies that pay dividends are most often companies that have progressed beyond their initial ‘high’ growth phase.

Sometimes companies no longer benefit sufficiently by reinvesting their profits. They may then decide to pay out an increasing part of their net 'surplus' profits to their shareholders.

When these kind of companies start to pay regular dividends than holding shares in them becomes increasingly appealing to a certain type of investors - the income investor.

Dividends of these kind of 'stable' companies normally offer a consistent return on a relatively low-risk investment. While these companies continue to grow, albeit often slowly, the dividends themselves may also grow, providing ever more value and return to the income investor.

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