What are dividends?
If you are interested in investing and the stock market, you have probably heard the word dividend. It often appears in connection with funds or individual stocks. By purchasing a stock, you can acquire a share in a company.
Dividends allow investors to participate in the profits of the respective company. In this article, you will learn exactly what dividends are, why companies issue them and how you can benefit from them.
In brief:
- Dividends are a share of a company’s profits distributed to its shareholders.
- With the help of a dividend strategy, you can regularly earn a share of the profits.
- There are different types of dividends
Dividend – what is it?
Investors buy stocks and thereby provide companies with capital to further expand and grow their business. In this way, investors become co-owners of the company whose stocks they have purchased. In return, investors receive a share of the profits generated by the capital they have invested. This can take the form of dividends.
Good to know:
Distributions are performance-related and are paid out when companies perform well and report a net profit. This means that dividends can vary in amount from year to year.
It is important to note that shareholders have no legal claim to dividends. The Annual General Meeting decides each year whether a dividend will be paid and how much it will be. Profits are distributed per share. In most cases, payment is made a few days after the company’s Annual General Meeting.
There are different forms:
- Cash dividends: The usual form, where the dividend is paid out in cash.
- Dividends in kind: Dividends are paid in the form of an asset, for example by issuing additional shares.
- Overdividends: This is the additional amount that preferred shareholders receive.
- Preference dividends: Unlike ordinary shareholders, preference shareholders are entitled to a higher dividend.
- Stock dividends: Additional shares are issued. Shareholders are not required to provide any further consideration.
- Interim dividends: In a few exceptional cases, advance payment of dividends is approved.
Amount of dividends
The shareholders of a company can decide for themselves what to do with the profits made. A company holds an annual general meeting. This is where investors meet to vote on how the profits should be used. The board of directors of the company announces in advance how much the investors will be voting on.
In such votes, each investor has as many votes as they hold shares. The dividend per share is generally determined and varies from year to year. As there is no legal entitlement, all investors must accept the decision of the Annual General Meeting.
In some cases, major shareholders may want to receive profit distributions even though the company has posted losses. The capital must then be drawn from the company’s assets.
Recipients of dividends
Every investor who holds a share of the company in their securities account will receive the full dividend. It makes no difference whether someone became the owner of one or more shares during the year. The dividend will be distributed to all current shareholders per share.
However, what can make a difference is the amount. Investors who own preference shares receive a higher dividend. The difference is that they do not have voting rights at the annual general meeting. Ordinary shareholders receive a lower dividend but have voting rights.
When will the dividend be paid?
Companies can choose when to pay dividends. They can be paid monthly, quarterly, half-yearly or annually. In Germany, however, dividends are usually paid shortly after the annual general meeting, approximately three days later. In the United States, dividends are often paid monthly.
The majority of companies in Germany hold their annual general meetings every spring. Private investors should not be concerned if payment is delayed by a few days. Companies may also decide to postpone payment dates.
Attention!
Dividend calendars are available online, showing the next known dates for payments. You can find more information on the websites of the respective companies.
Not every company pays dividends to its shareholders. Even many well-known companies, such as Google, have decided against distributing dividends. There are various reasons for paying or not paying dividends.
Companies primarily pay dividends to shareholders when they have no meaningful projects for which they need the assets. Corporations that do not pay out dividends use their profits to reinvest. In such cases, capital can flow into research or other investments. This enables them to further develop the company and continue to benefit from growth in the future.
Good to know:
Another option is to pay off debts. Companies often borrow money in advance. With the help of profits, they can pay off interest after periods of growth. Some corporations also retain their profits in order to build up financial reserves for difficult times.
There are therefore many reasons why companies choose not to pay bonuses. That is why companies normally decide to do so when they have made significant profits. Nevertheless, there are also corporations for which dividend payments are the norm and also desirable. This can also happen when companies have made losses and have to draw on their reserves to pay out the dividends.
Is there a dividend ETF?
An ETF that tracks the MSCI World Index, for example, covers around 85 percent of the market capitalisation of 23 industrialised countries. Dividend ETFs are another option. These funds only select companies that offer particularly high dividend yields.
Dividend ETFs often include pharmaceutical companies, food companies and manufacturers of everyday goods. Technology companies are rarely represented, as they seldom pay dividends to their shareholders. If you would like to read more about the exact provisions, you can do so in the respective dividend index.
A dividend ETF differs from ordinary ETFs in that it usually offers a slightly higher return. However, there is also a disadvantage: while the normal MSCI World index includes 1,800 companies, a dividend ETF contains around 300 corporations. This leads to significantly lower diversification, which also increases risk.
Good to know:
Nevertheless, a dividend ETF can certainly be an exciting option for some investors looking to expand their portfolio. Examples include the MSCI World High Dividend Yield Index and the FTSE All-World High Dividend Index.
What is a dividend strategy?
A dividend strategy involves a method of investing specifically in companies with high payouts. This allows investors to receive regular shares of profits. However, it is important to bear in mind that dividend strategies offer little planning security.
A company’s shares fluctuate from year to year and are often based on how well or poorly the group performed during the previous year. The exact amount of the dividend for the year is only decided at the annual general meeting.
In addition, it may make financial sense not to invest specifically in companies with high dividends, but rather in an accumulating ETF. This does not distribute profits, but reinvests them so that you can benefit from a higher compound interest effect.
Taxation of dividends
In Germany, profit shares, capital gains and interest are subject to taxation. It is important to note that capital gains tax is part of the withholding tax. Your bank or broker will deduct this and pay it directly to the tax office. The rate is 25 percent. However, church tax may also be payable in some cases.
If you receive dividends from foreign companies, withholding tax is often levied in the home country. If there is a double taxation agreement between the two countries, banks in Germany will offset the withholding tax against the flat-rate withholding tax paid abroad. This often results in a tax rate of 15 percent.
Good to know:
You should not forget to set up an exemption order. This allows €1,000 per person to remain untaxed. If you receive profit shares from different portfolios at different banks, the allowance must be divided between the various institutions.
Conclusion: How dividends work
When an investor buys a stock, they become a co-owner. Some companies pay dividends to their shareholders. These payments vary from year to year depending on the company’s performance. The annual general meeting decides whether and how much to distribute.
It should be noted that not every company pays out royalties. Normally, companies only distribute dividends if the company has performed well and has surplus capital. Many corporations use surplus profits to invest in other projects such as research, to pay off debts or to build up financial reserves for difficult years.
There are different ways to profit from royalties. Investors can invest in individual companies that pay out high profit shares. Another option is dividend ETFs, which only contain companies with comparatively high dividends. However, these offer little diversification.
FAQ – Frequently asked questions about what dividends are
