What are dividends?
In the section "What are theActions?” We explain how companies are financed through actions. Shareholders have the right to participate in the profits of the company in the event that it decides to distribute them. Dividends are the distribution of part of the profits of the company among the shareholders. Here we are going to see why companies distribute dividends, what types of dividends exist, who determines the amount of those dividends and in the end we will see if companies that pay high dividends are automatically better investments.
1.- Why do companies distribute dividends?
Dividends are a partial distribution of the company's profit, so they generally depend directly on whether the company has made a profit.
When a company generates profits, with that money it has several options:
1)reinvest it in new company projects,
2)pay debts,
3)increase your reservesand
4)distribute it among its shareholders.
We see that only in one of these four options do companies pay dividends, it is therefore important to clarify thatNot all corporations pay dividends.. A clear example of the first option is Google, which has not paid a single dollar in dividends in its entire history and the new parent company Alphabet does not plan to do so in the future either. From a company's point of view it only makes sense to hand out money to shareholders when there is in quotes “nothing better” to do with that money. You may be wondering right now: Wait a minute, isn't the company's goal to generate profits for its shareholders? Generate profits yes, but not necessarily to distribute them among its shareholders.
Companies like Google, for example, think that they can invest their profits in better projects than their investors would invest in other alternative investments in the stock market. If the company is in a growing market, it will prefer to reinvest the money in itself and thus grow the company much faster. That money is often used in Research and Development to try to increase its market share and produce higher profits in the future or to expand its operational activities such as penetrating new markets, acquiring new companies or investing in new business models.
The second of the options was to pay the debt in the event that the company had to request a loan from the bank to finance itself. The profits obtained can be used to pay the interest and the principal of said credits.
Sometimes companies, as is often the case with banks, prefer to use their profits to preventively increase the company's reserves and thus cover future eventualities.
We have just seen the three options that companies that generate profits but do not pay dividends have. We are now going to see why there are companies that do distribute dividends.
The shareholders of large companies and already consolidated corporations, which are no longer innovative and growing companies, expect them to pay dividends. In general,the benefits are usually greater than the projects in which the company plans to investand so shareholders want to see cash.
In many industries it has also become customary to pay dividends every year. Thus, for example, in 2015, a year in which the energy giants did not do very well, Repsol continued to constantly distribute dividends, even when its profits plummeted, to keep its investors happy. It is not necessary to go so far in the past, in 2019, one of its subsidiaries, Repsol Petróleos SA, also distributed dividends charged to reserves.
These large companies and corporations are called “Bluechips” in financial jargon and are companies with low fluctuation in the share price, that generate solid profits year after year and pay part of these profits to their shareholders.
2.- Types of dividends
There are different ways to classify dividends. Yeahwe attend to the forms of paymentThere are two types:
1) dividendscashIn this case, the company transfers the proportional part of the profits in money to the shareholder's securities depository.
2) dividendsin shares, called in English "scrip dividends", in which shareholders, instead of receiving money, obtain new shares of the company in question.
Depending on the time of deliveryDividends can be classified as follows:
1) dividendsordinary, are those that are scheduled in the company's calendar and that you know you are going to collect on a certain date.
2) dividendsextraordinary, are those that the company decides to distribute when it has obtained more profit than expected thanks to an extraordinary activity.
3) dividendson account, are those obtained by the shareholder before the end of the fiscal year.
4) dividendscomplementary, are those that are paid once the fiscal year has ended and when the accounts have been approved.
5) dividendpermanent, is the dividend set by the company regardless of the profits obtained in the year.
In general, companies usually distribute dividends twice a year. There are North American companies that distribute dividends every quarter and there are even Canadian companies that distribute dividends every month. The dividend payment calendar of the companies is easily found on different web pages on the Internet, such as atinvesting.com.
3.- How and who sets the amount of dividends?
The first thing is to know that the dividends depend on a fairly basic question: Is there money in the account or in the box to pay the dividends? On very few occasions, companies request loans to pay dividends, we would be talking about an exception.
The board of directors of the public limited company is in charge of presenting the company's accounts to the shareholders in the general assembly and proposing the amount of dividends.The shareholders, who are the owners of the company, decide by simple majority whether to accept the proposal or reject it.. So you could say, they arethe shareholders themselves, those whodetermine the amount of dividends. As we saw in the share types video, this is not valid for preferred shareholders, since they do not have voting rights.
Since 2016, there are somekey dates that regulate the distribution of dividends.
First is thestatement dateeitherdeclaration datein English, which is when the board of directors announces the amount and date of the distribution of dividends. The declaration date must be at least two months before the payment date.
Then there's theex-dividend dateeitherex dividend datein English, before which you have to have bought the share if you want to be able to access the next dividend.
Then comes theregistration dateeitherrecord date, in which the company makes official the shareholders who are going to collect the dividend.
And lastly, thePayment date, which is when the dividend payment materializes.
It is very important to know that when a company distributes dividends, the share price on the ex-dividend date falls more or less by the same amount as the dividend. Let's see this with an example. Suppose that the share of our company XYZ SA trades one day before the ex-dividend date at €10 per share. It was decided to distribute a dividend of €0.5 per share on the declaration date, therefore on the ex-dividend date the price of our share will drop €0.5 and stand at €9.5._cc781905-5cde- 3194-bb3b-136bad5cf58d_
This is done to prevent smart people from buying the stock the day before the dividend is due, depositing the dividend, and selling the stock right after.
4.- Are companies that pay high dividends automatically better investments?
We now turn to the question of whether companies that pay out high dividends are automatically better investments. As I suppose you may have already guessed, the question cannot be answered with a clear Yes or No.Dividends by themselves don't say anything. You have to always consider dividends in context with the profits of the corporation and also in relation to the company's price.. These two ratios are very interesting metrics that tell you if the dividends are attractive or not. What is the metric that relates earnings to dividends? This indicator is calledpayoutand it is thepercentage of profits that the company allocates to shareholder in the form of dividends. The average Payout of Spanish companies is between 30 and 50%.
The metric that represents theThe relationship between dividends and the company's share price is the dividend yield.. We are now going to calculate the dividend yield of our company XYZ SA whose price was €10 per share and we had said that the dividend per share was €0.5. If we divide the dividends of €0.5 by the €10 share price, we obtain a dividend yield of 5%. For every Euro that you have invested in the XYZ public limited company at the market value of €10, you will obtain a 5% dividend yield. If you have bought the cheapest share of €10, you will be obtaining a higher return thanks to the evolution of the value of the share. The return can also be negative if you have bought the share at a price greater than €10 per share.
When both metrics come together, that is, a decent dividend yield that comes from sustainable corporate profits, then we talk about Value Investment. This investment strategy is the one that Warren Buffett has followed throughout his life and his success precedes him.