Tax & admin · 16 January 2018

What are dividends and why are they important?

Dividend
A dividend is a proportion of the amount a business earns 

Writing for Business Advice, Qudini’s Rob Drury explains to readers what are dividends, why they’re important, and who’s most likely to pay them.

If you are the shareholder of a business then asking what are dividends is something you’re going to want to do to maximise your return on investment.

If you’re the shareholder in a business then there’s a fair chance that you are invested in that business in order to make some money.

One way of making money from owning a share of a business is through an increase in the value of your shares, so that when you sell it you pocket the difference.

However, another way is through getting a proportion of the value that the business earns, which is called a dividend.

What are dividends?

Put simply, dividends are payments agreed by the board of directors of a business to reward the shareholders for the earnings made by that business.These payments are paid periodically, perhaps monthly or quarterly, and could take a number of forms.

The most straightforward form is through a monetary payment at a value per share, for example, a £1 dividend for each share held. However, dividends could take the form of further shares, or occasionally other assets.

The first recorded issuing of dividends came from the Dutch East India Company, who issued dividends totalling 18 per cent of the value of the shares each year from 1602 all the way through to 1800, making for a very profitable investment for it’s shareholders.

Who offers dividends?

Typically, a younger business or one that is undertaking a period of high growth does not offer dividends to its shareholders, as it’s more likely to be reinvesting any profits it makes back into the business to support its growth strategies.

With these businesses, shareholders ultimately receive value for their investment through increases in the value of their shares.

More likely to offer dividend payments are larger, more established businesses, whose growth and profits are more predictable. Expert’s 2018 picks for good dividend returns include Marks & Spencer, BP and GlaxoSmithKline, for example.

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It’s these kinds of businesses that have shareholders who are investing to get a return from dividends, rather than through large scale share price increases.

In the second quarter of 2017, shareholders of companies listed on the main UK stock exchange received £33.3bn in dividend payments, including a £3.2bn payment to shareholders of the National Grid, and over £1.5bn to Lloyds Banking Group investors.

The issuing of dividends becomes the incentive for shareholders to remain as investors in a business, through providing regular payments that deliver immediate value, as opposed to the uncertain potential of future share value growth.

In fact, typically a business that offers dividends may see a dip in its share value after the issuing of dividends, as there becomes an expectation that dividends won’t be issued again for a period of time, so there will be limited opportunity to obtain a return. 

What are the advantages of dividends?

In addition to the obvious fact of receiving payments, there are added tax advantages when it comes to receiving dividend payments.

In the UK, the first £5,000 of dividends that you receive as a taxpayer are completely tax free, regardless of your other personal income, so there are advantages to be had for those who own part of a business.

Other countries follow similar advantages, with the US and Canada providing lower tax rates on dividend income.

There have been a number of studies that have shown that when dividends are offered, a business will benefit from higher earnings growth, which provides confidence for its future.

However, a counter argument, which is taking hold in some sectors, is that a willingness for a business to lose finance in the form of dividends indicates that the owners have few ideas for growing the business, as they act as if they don’t need the cash to support future growth.

Robert Drury is oversees product management at customer experience software business Qudini
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ABOUT THE EXPERT

Former footballer and cinema manager Robert Drury has been a digital professional since 2000, specialising in project management, client services, and product management. He supported global brands such as Kraft Foods, Peugeot Citroen, and Lloyds Banking Group with their online presence before moving into startups. He was a founding team member at Ormsby Street, a small business financial information tool, before moving to Qudini to oversee the development of that firm's customer experience software product.

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