Editor’s note: This article was first published in December 2012. The market figures are from then: Banco Santander at 5.90 euros with a 0.15 dividend, Apple down 27% since announcing its dividend, and IBEX 35 dividend yields such as FCC 12.8%, BME 11.7% and Santander 10.4%.
Many people ask us basic questions about dividends. To explain simply what dividends are: when we buy shares, we are buying a “little piece” of the company. In other words, by buying shares you become part of the company, so you have a voice and a vote at its shareholder meetings (political rights) as well as the right to share in the company’s profits (economic rights). This distribution of profits to shareholders is known as dividends.
That said, choosing a company because it pays higher dividends is not always the best choice for an investor. We need to understand that the dividend is not a bonus or a gift. The dividend payment is deducted from the share price. For example: Banco Santander closes at €5.90 per share. If it pays a dividend of €0.15 tomorrow, the stock would automatically open the session at €5.75. The dividend is a percentage of the company’s profit, so once it is paid (since it comes out of the company’s capital), it has to be deducted from its market capitalization.
To begin with, we should invest in companies that are on the rise. Take Apple as an example: this company never paid dividends and has gained 114,800% since 1981. A few months ago it announced that it would start paying dividends, and since then it has lost 27%. At the end of the day, when we invest in the stock market we are looking to make money, so if a company is rising and has potential, the dividend matters least.
Of course, if a company has upside potential and also pays good dividends, so much the better. At other times, it is the shareholders themselves who decide at the meetings that a company should not pay dividends and should use that money to pay down its debt or invest it in growth.
High dividends are sometimes a bad sign.
Some companies have lost 50% of their stock market value, and the outlook does not seem likely to improve in the short or medium term, so one way they have of making the company attractive to investors is to pay a good dividend. In this case, though, the dividend does no good.
First, if the company loses 30% of its value and pays a 10% dividend, we are still losing 20%, so the numbers do not add up.
Second, if the company is falling, paying the dividend will help it lose even more value. Unlike with a rising company, where new investors take advantage of that small dip at the time of the payout to buy in, with falling companies many investors sometimes sell out before the payout as soon as they learn that a dividend is coming.
And third, if the company is so indebted that it has to carry out a capital increase to pay the dividend, it is doubly unattractive for the investor.
Choose dividends that are sustainable over time.
This is one of the pieces of advice from Warren Buffett. We should choose solid companies that pay good dividends, but those dividends need to be sustainable over time. If we invest with a long-term mindset, as long as the dividend keeps being paid and we have no intention of selling our shares, at least every year we will receive 5, 7 or 10 percent in dividends, which is already better than a fixed-term deposit.
The top dividend payers in the IBEX 35 so far have been FCC (12.8%), BME (11.7%), ACS (11.48%), Santander (10.4%), Iberdrola (8.9%), Indra (8.7%), CaixaBank (7.8%) and Repsol (7.67%). (Dividend yields on nominal value.) Inditex will also make a strong showing on dividends. However, not all of the companies named will be able to maintain their dividend, and others will face constant doubts. Take Banco Santander as an example: despite the falls caused by the crisis, the dividend has cushioned the losses for long-term investors.
Is it better to receive the dividend in cash or in shares?
Large investors prefer the dividend in cash, because if you have €3 million in shares and receive a 7% dividend, every year you will get roughly €210,000. That is an income-producing asset.
For small and medium investors, on the other hand, it is better to receive dividends in shares (at least in my personal opinion), because cash, as a rule, gets spent. Receiving them in shares means automatically reinvesting the profits, and as the share price rises, it would be as if we had received more money than at the start.
Other frequently asked questions about dividends:
Who can collect them, and when? Anyone who holds shares on the day before the dividend is paid is entitled to collect it. In other words, if a company pays a dividend tomorrow, you can buy the shares today before the market closes and you would collect your dividend tomorrow. But be careful: this strategy, which some people use, does not always pay off because, as we said at the start, the payment is deducted from the share price.
Do I have to remain a shareholder for a minimum period to collect dividends? Not at all. Going back to the previous example, if you buy shares today and the dividend is paid tomorrow, you can sell them tomorrow.
Further reading
Featured image: unknown author, Public domain, via Wikimedia Commons.
