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A Guide To Dividend Investing

July 08, 2020 15:17 UTC

Do you know what dividend yield is? Have you ever heard of the dividend adjustment of stock indices? If not, and you are interested in learning more about dividend investing, read on! In this article we will tell you all about dividends and how these terms can affect your profitability as a stock trader

Dividend Investing

What Is Dividend Investing?

Investors who own shares of listed companies can earn profits through two different channels:

  1. An increase of share price in the market
  2. The collection of dividends

A dividend is a portion of the profit which a company distributes among its shareholders and is classified as a liability on the company's balance sheet until it is paid.

Dividend investing, therefore, is a strategy utilised by traders who specifically target stocks which pay dividends. They do this in order to receive a regular income from the dividend payments.

A company's board of directors will determine whether a dividend will be paid and how much it will be. The payment must then be approved by the shareholders via a vote.

The remainder of the profits are usually used for investments by the company's management. This means that, in general, fast growing companies facing lots of opportunity (e.g. Tesla) tend to pay a lower proportion of their profits out as dividends than companies in more mature industries that are growing more slowly (e.g. Tesco).

Schedule of Dividend Payment

Dividends are usually paid semi-annually, although some companies pay them quarterly and others annually.

As well as determining a percentage of profits to allocate to dividend payments, the board of directors will also set a "record date". This is the date when the company will look at its share register to determine who its shareholders are and, therefore, who is eligible for the dividend payment.

Consequently, in order to qualify for the dividend payment, you must be a registered share owner on the record date. There is a lag of a few days between the time shares are traded and the update to the share register. This means that it is necessary to actually purchase shares at least two business days prior to the record date to ensure you are registered in time. This date is known as the "ex-dividend date" and it indicates to possible investors that if they have not purchased shares before this date, they will not qualify for the scheduled dividend payment.

Because of this, shares will usually fall in value on the ex-dividend date by the amount being paid in that dividend. For example, assume Company X is due to pay £1 in dividends and the ex-dividend date is tomorrow, if its shares ends the trading day today at £25, then tomorrow's official opening price will be £24. This adjustment can affect indices, which we examine below.

If you are interested in learning more about dividend investing and other trading topics, why not register for one of our free webinars? You can sign up by clicking the banner below:

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Types of Dividends

There are several types of dividend which exist:

  • Cash Dividend
    • This is by far the most common method of making dividend payments. As the name implies, the company pays the value of the dividends to its shareholders in cash
  • Stock Dividend
    • If a company lacks operating cash, they may choose to issue additional shares to shareholders, who receive these "bonus shares" proportionately based on the amount of shares they hold
    • The company does this by increasing the number of outstanding shares in the company, similar to a stock split
  • Property Dividend
    • As with a stock dividend, property dividends may be issued when a company lacks sufficient operating cash to pay a cash dividend. This type of dividend is paid in the form of physical assets which are no longer needed by the company
  • Scrip Dividend
    • In this circumstance, the company issues a promissory note to shareholders which confirms the payment of a dividend on a future date. This promissory note may be interest bearing, but does not have to be.
    • This scenario may occur when the company requires additional time to convert current assets into cash
  • Bond Dividend
    • A bond dividend is very similar to a scrip dividend, but has a maturity (or payment) date which is further in the future. These bonds are always interest bearing
  • Liquidating Dividend
    • This last type of dividend occurs when the company pays back the original capital investment of the shareholders and is generally seen as a precursor to the business shutting down

The board of directors decide what percentage of profits will be paid to shareholders as dividends as well as the way in which they will make the dividend payment. They then submit the proposal to a vote at the Annual Shareholders Meeting.

How To Calculate Dividend Yield

The dividend yield shows how much a company pays out in dividends each year in relation to its current share price and is, therefore, a very important factor to consider when dividend investing.

In order to calculate the dividend yield, we must divide the annual dividend per share by the current share price and then multiply the answer by 100.

Example:

Company A has paid a total dividend of £0.25 per share over the last 12 months and its current share price is £6.85.

Dividend yield of Company A = (0.25 / 6.85) * 100 = 3.65%

Dividend Tax Rate UK

The collection of cash dividends is considered a return on capital and is therefore taxable in the UK. However, there is an annual dividend allowance, which is not taxable, currently £2,000 for tax year 6 April 2020 - 5 April 2021.

The amount of tax you pay on dividends above £2,000 is based on which income tax band you are in.

Source: GOV.UK - Tax on Dividends - 6 April 2020 - 5 April 2021

Dividend Adjustment in the Indices

As we saw above, the price of shares will be affected by dividends on the ex-dividend date. This, in turn, will affect indices.

Most popular indices like the FTSE100 and the S&P500 simply aggregate the prices of a group of shares and ignore the fact that some price movements are caused by the effect of the ex-dividend date.

This means that if a handful of large index constituent companies are paying large dividends and have the same ex-dividend date, then that index will be subject to some predictable downward pressure on that date.

Other indices, usually labelled as "total-return indices", try to capture the total returns of a group of shares, including dividends. These indices are not subject to the same ex-dividend-induced volatility.

For example, the DAX-30 has two versions: a "price index" version and a "performance index" version which captures total returns. Unusually, it is the performance index which is most commonly used.

IMPORTANT: It is important for any investor trading index derivatives to understand the treatment of dividends by the index being traded.

With Admiral Markets you can trade the FTSE100, S&P500, DAX-30 and many other indices using Contracts for Difference (CFDs). CFDs have various benefits including low margins and the ability to leverage.

Trade the world's top markets with Admiral

Trade CFDs on the DAX 30

CFDs allow the possibility of profiting from both the upward and downward price movements of an asset. They also allow you to trade using leverage.

If you are a retail client (non-professional trader) you can access leverage of up to a maximum of 1:30 trading on CFDs in the UK. Admiral Markets offers a maximum leverage of 1:20 for CFD retail clients. Let's look at an example of how CFD leverage works below:

Let's imagine that we want to open a buy ("long") position on the DAX30 CFD:

  • We open the position at 9000 points
  • The cost of this position is €9,000
  • Our broker offers leverage of 1:20
  • Margin = 9,000 / 20 = 450

The margin indicates the amount of money the trader is required to have in their account to open this position. Therefore, in this example, we would require €450 in our trading account in order to complete the transaction.

Leverage can be used to increase your potential profit, however, you must be careful as it can also increase your losses if the market moves against you. In order to illustrate this, let's continue the above example with two different possible outcomes:

  1. Example 1: The DAX30 increases to 9050 points and we decide to close our position. In this circumstance, we have earned a profit of €50 as the market has moved in our favour
  2. Example 2: The DAX30 loses value and we close our position at 8950 points. Because the market has moved against us, we have sustained a loss of €50

With Admiral Markets, you have the ability to decide the value of each point on the DAX30. This can be €1, €2, or €50 depending on the number of contracts per order. Therefore, if the DAX30 moves 10 points, you would win or lose €10, €20 or €500 respectively.

Trade DAX30 with MetaTrader 5 Supreme Edition

The MetaTrader 5 Supreme Edition add-on from Admiral Markets allows you to easily trade CFDs with the DAX30. Below we will look at some of the available features.

The Mini-Terminal allows you to set the amount you want to trade in Euros, as well as easily open and close your positions, with the additional possibility of partial closures. You also have the option of hedging your open positions on the stock exchange.

DAX30 Hourly Chart MetaTrader 5Source: Admiral Markets MetaTrader 5 with MT5SE add-on. DAX30 H1 Chart. Captured on 7 July 2020 at 13:55 GMT. The sole purpose of this chart is to illustrate the content of the article and in no way implies a recommendation for trading.

The trading terminal allows you to effectively and efficiently manage your DAX30 trading account and all your open orders. With the Supreme Edition add-on you will also have access to numerous additional price indicators to help you get more information out of the charts. The trading simulator will allow you to test your trading strategy with the DAX30 on historic price data.

If you would like to practice trading the DAX30 using CFDs in a risk-free environment, you can open a free demo account with Admiral Markets by clicking the banner below:

Risk Free Demo Trading with Admiral Markets

About Admiral Markets

Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.