This is because dividends may increase shareholders’ total returns, by providing a regular source of income in addition to the money they could make if their shares grow in value.
Having said that, no company is obliged to pay a dividend and many investors are also happy to buy shares in companies that do not, if they believe the profits can be put to better use.
For example, a company may instead reinvest its money into the growing business, with the goal of generating more earnings in the longer term (and subsequently increasing the value of the shares).
In the case of real estate investment trusts (REITs) and some other types of listed funds and entities, the payment may instead be referred to as a ‘distribution’, which is allocated per unit or security.
Franked or unfranked
Dividends can be declared as fully franked, partially franked or unfranked.
When dividends are ‘franked’, it means the company has paid tax on the profits and shareholders don't have to pay tax again on the same money.
They receive a ‘franking credit’ attached to each dividend, which may allow them to reduce the amount of personal income tax they need to pay.
When dividends are ‘unfranked’, it means the company has not paid tax on that money. As such, shareholders don’t receive any franking credits.
When a company announces a dividend, its share price will sometimes rise afterwards as investors buy stocks ahead of the ex-dividend date.
An ex-dividend date means the day the shares begin to trade without the entitlement to the latest dividend. You would need to buy shares before this date to receive the dividend payment.
Some investors use dividend yield – the value of a dividend relative to the share price – to compare returns on investment.
You calculate the ratio by dividing dividends paid over the past 12 months by a company’s current share price and express it as a percentage.
It is important to note, however, that the dividend–price ratio should serve as a guide only, as you should also take into consideration many other aspects of a company’s operations and fundamentals before making any investment decision.
Dividend reinvestment plan
Not all companies offer dividend reinvestment plans.
For a company that has such a plan in place, shareholders often have the option of either receiving a cash payment or reinvesting their dividends to receive new shares in the company, or a combination of both.
Sometimes the company will offer these new shares at a discount to their current market price, although they are not obliged to do so.