Methodology

Stocks

Module 1

Dividends

Another way that investors can make money from investing in stocks is to receive a dividend. A dividend is income that an investor receives on a regular basis. It is paid to the investor from the profits that the company earns. 

 

Dividends are usually given as a percentage of the stock price. For example, a company may decide to pay a dividend that is worth 3% of their stock price. So, if the stock price is $100, they would pay $3 to the investor for every stock that they own.

 

The percentage that a company offers will vary from one to another. A typical dividend would be at around 3% of the stock price, but it could as low as 0.5% or as high as 10%. Although a high dividend may sound attractive, it can be a sign that a company is experiencing financial difficulties. This is the case because the stock price would have likely fallen a lot, making the dividend percentage much higher. 

 

Dividends are usually paid on a quarterly basis but can be paid semi-annually or annually. Occasionally, companies offer a random dividend to reward investors for the success of the company, which is known as a ‘special’ dividend. 

Do all stocks offer a dividend?

Not every company offers a dividend to shareholders, which means that an investor can only make a profit through capital gains. Dividends are usually very expensive for a company to finance so they may decide not to offer one as the company can’t afford it or because they would prefer to use the money to invest in new projects.

 

Whether a company offers a dividend or not often depends on the industry that the company operates in. Some industries have a lot of opportunities for growth, so in this situation, companies tend to decide that their money would be better used in those projects. If those projects are successful, it will increase the size of the business and increase the stock price. Such companies believe that their shareholders would prefer to receive larger stock market gains (i.e. 30% a year) than to receive a 3% dividend. This usually happens in the technology industry, where few companies offer dividends.

 

Aside from the industry that a company operates in, whether a stock comes with a dividend or not depends on the stage that a company is at in the development cycle. More mature companies are much more likely to offer dividends, while start-up or growth companies are much less likely to, as they need the cash to develop the business further.

Dividends & tax

As dividends are a form of income, investors can expect to pay tax on those payments. Despite being a form of income, dividends are usually taxed separately from other forms of income (i.e. your salary). This obviously varies from one country to another, so you should seek out information that specifically relates to your country.

 

In many countries, it could be the case that certain investors do not pay any tax on their dividends at all. For example, in the UK, investors do not pay any tax on their dividends unless they receive more than £2,000 in dividends a year.

 

So, if you mostly invest in stocks that do not pay a dividend, you may not pay any tax on your dividends at all.

 

In a lot of countries, the tax rates that individuals pay on their dividends is usually less than they pay on usual income. For instance, in the USA, investors pay a maximum of 20% tax on the dividends they receive, which is a lot lower than the maximum tax rate of ordinary income (37%). As stated, dividend tax policies are specific to your individual country, so make sure that you find out what the rules are for you.

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