Two Important Points About Dividends

It’s no real secret that the total returns investors can get from a share comes from the sum of its capital gains and dividends. In particular, the latter is the distribution of a slice of a company’s earnings.

Management can decide to pay out dividends to shareholders once a year, semi-annually or even quarterly. Some companies might even have a written policy of how much dividend  they would be paying out each year.

In certain cases, such as Singtel (SGX: Z74), the returns from its dividends over the past few years can even be higher than its capital gains.

Given the importance of dividends, we should really take a closer look at the motivation behind management’s intentions to pay a demand and how it will affect the performance of a company and its share.

Why would a company want to pay a dividend?

There are many reasons why a company’s management might choose to pay out a dividend instead of reinvesting all of the company’s profits.

For one, it could be a case of a company reaching maturity and there just simply aren’t enough capital reinvestment opportunities available. In such an instance, the company would choose to reward shareholders by distributing its earnings to shareholders in the form of dividends.

However, companies might also choose to pay out dividends for more selfish reasons. For example, if a company’s operating in a region where personal taxes are much higher than the corporate tax rate and the company’s upper-management are also its major shareholders, the management team might choose to declare a high dividend to save on their personal taxes and increase their own personal payout. Fortunately, such scenarios generally do not happen in Singapore’s stock market due to the lower personal tax structure here.

Does a stock trade lower after the ex-date?

In theory, a company’s share price would decrease by the same amount as the dividend it is paying out on the day payments are made to shareholders. In practice, this might not always be the case, especially with companies making regular dividend payments.

However, it should also be noted that the theory is generally true for companies that are paying out a special or large dividend. For example, Fraser and Neave (SGX: F99) paid out a dividend of S$3.19 per share on July 2013. On the day the dividend was paid out, the company’s share price dropped by roughly the same amount.

Foolish Bottom Line

Dividends will continue to be a major attraction for investors when it comes to choosing their next investment and companies that give out consistent dividends tend to be valued higher than those that do not.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.