Last updated: June 16th, 2024
Dividend investing is an investment strategy that can help Australian investors increase their net worth or generate additional income streams. These are usually paid by established, ex-growth Australian companies (e.g., BHP and Westfarmers) with stable, healthy cash flows.
I became interested in dividend investing because I was terrible at investing.
- My businesses generate a healthy profit, which means I have thousands of dollars in surplus cash accumulating in my bank accounts each month.
- Earning a 0.35% interest rate while depreciating 7.8% annually, courtesy of NAB and soaring Australian inflation, respectively.
Like I said, terrible.
I learned everything about buying dividend stocks in Australia, calculating average dividend yields, dividend taxes and franking, the relationship between dividends and shares, and more – and shared it here. Enjoy!
(Related: How To Buy Apple [APPL] Stocks).
How Do Dividends Work?
A dividend is a payment of profit made from a company to its shareholders. It is proportional to the number of shares you own.
Dividend stocks are:
- Known for their consistent, recurring nature.
- Usually paid out on an annual or semi-annual basis.
- Between 0.5% – 10% of the total share value, annually.
- Paid from a company’s annual earnings and long-term cash flow.
Important!
You can create an income stream by withdrawing your dividends, though academics warn that this is a blunder known as the “Free Dividends Fallacy“. They advise you to view dividends as a shift of capital from the stock price to the dividend, rather than additional income.
Do All Companies Pay Dividends?
No. Companies can:
- Decide to skip or delay dividend payments (e.g., if they’re having a financially difficult year).
- Create a policy of not paying dividends. An example of this is Tesla, which makes a point of reinvesting all profits into the company to fuel further growth.
How Dividends Affect Stock Prices.
You can’t have it all.
Companies that pay high dividends usually see modest stock price increases. They are ex-growth, large cash-flow businesses.
Cash cows.
Did You Know?
Australia’s top dividend stocks are typically in the mining, energy, real estate and financial services sectors.
How do you spot a cash cow?
- Singe-digit year-on-year top-line growth.
- Lean balance sheet.
- Conservative investments in high-risk projects.
Growth in these companies is achieved through cost-cutting and financial engineering (e.g., stock buybacks) rather than innovation.
Important!
In rare situations, high dividend yields can indicate a financially crippled business. Scroll to the bottom of the article to learn more – and verify that shareholders are not milking the cow for all its worth in its final days.
How To Evaluate Dividends.
Specific metrics help determine whether a dividend will get paid, how much the payment will be, and when the payment will happen. Pay attention to these numbers:
1. Dividend Yield.
A dividend yield is the total amount paid out in profits throughout a set period, divided by the current share price.
If a company pays dividends quarterly, the dividend yield would be the sum of four quarterly payments over one year, divided by the share price at the end of that period.
Example.
A company paid out $10 per quarter in dividends, and the price per share was $10. The dividend yield would be $40 divided by $10, or 4%.
The dividend yield represents the profitability of any particular investment beyond any share price growth.
The best place to compare dividend yield is the S&P/ASX 200 Index. You should also compare the dividend yield of competing companies to understand the figures in context.
Expert Advice.
Generally, a good payout range is 0%-35%, while an excellent payout range is between 36 and 55%.
2. Yield On Purchase Price.
A broader snapshot of overall growth (or lack of growth in a company). You can calculate this by taking:
- Current annual dividend by the share,
- Dividing by the average individual share cost,
- Converting it to a percentage.
Example.
You buy a stock at $2 a share and receive a dividend of 10 cents per share per quarter, for 40 cents per share per year. Your yield on purchase price would be $.40 / $2.00, equaling 2 (or 20% annually per share).
Depending on the economic environment, a company might raise or reduce its dividend yield, reflected in the overall dividend payout.
(Related: Interest Rate Forecast: When Will RBA Cut Rates?)
3. Payout Ratio.
This may be the single most important statistic in evaluating a dividend’s stability. The payout ratio helps you determine whether the company is able to sustain dividend payments over the long term.
- A high payout ratio could mean that a company is paying out more than it can afford and may not be able to maintain its dividend payments in the future.
- A low payout ratio indicates that a company is retaining more earnings for growth, which could be positive for future dividend growth.
The payout ratio can provide insights into the sustainability of a company and its potential for future growth.
(Related: How To Buy Microsoft Shares In Australia).
To do this:
- Find the company’s net income (typically, on the company’s income statement).
- Determine the total dividends paid to shareholders (found on the company’s cash flow statement).
- Divide the total dividends paid by net income (your figure will be the payout ratio).
Example.
If a company has a net income of $10 million and pays $2 million in dividends, the payout ratio would be 20% ($2 million / $10 million).
How To Start Investing In Dividend Stocks.
Your journey begins by opening a share trading account with one of Australia’s best share trading platforms.
Compare and choose one that’s right for your level, paying attention to:
- Trading and non-trading fees.
- User–friendliness of the platform.
- Whether the platform has an Australian Financial Services license, issued by ASIC.
Expert Tip.
Some platforms are best suited to infrequent novice and intermediate investors, while others expect you to make regular deposits and frequent trades.
Important Dates For Australian Dividend Investors.
Many investors monitor and plan investment strategies based on information released on important dividend dates. These are:
1. Declaration Date.
The Decaration Date is when a company’s Board will announce the next round of dividend payments.
2. Record Date.
The record date is a date set by a company’s board of directors that determines which shareholders are eligible to receive the next dividend payment.
An investor must be listed on the company’s record book as a shareholder on or before the record date to receive the dividend.
Example.
If a company sets a record date of May 15th, only shareholders listed with the company on or before May 15th will be eligible to receive the dividend payment.
3. Ex-Dividend Date.
The ex-dividend date is when a stock starts trading without the dividend included in its price.
Investors who buy shares on or after the ex-dividend date are not entitled to the next dividend payment.
Example.
If a company’s ex-dividend date is May 20th and the dividend payment is $2 per share, an investor who purchases the stock on May 20th or later will not receive that stock’s $2 dividend payment.
4. Payment Date.
The payment date is when the company pays the dividend to eligible shareholders. It is at least one week from the record date but typically up to one month later.
The company’s Board sets the exact date, which can vary depending on policies.
(Related: How To Buy Netflix Shares In Australia).
5. Dividend Ex-Date vs Dividend Payment Date.
The ex-date (short for ex-dividend date) is when a stock starts trading without the dividend in its price.
- If you buy a stock on or after the ex-date, you will not be entitled to receive the next dividend payment.
- The payment date is when the dividend is paid to shareholders (as mentioned above) who owned the stock on or before the ex-date.
Keep track of both dates when investing with dividends, as they can significantly impact the timing of your income streams and overall investment strategy.
How Taxes And Franking Impact Dividends.
In Australia, the government taxes dividends as personal income. Even if an investor reinvests their dividends into a stock, the reinvestment is taxable.
This process leads many Australians to utilise franking credits.
The credits are a formal acknowledgment from the Australian government that a company’s dividend payment has already been taxed (at 30%) as a corporate tax on profits.
The credits also:
- Serve against other income taxes an investor might own
- Allow an investor to cash in, if the investor has no taxable income
- Create a scenario where a dividend creates more wealth beyond the dividend payment.
Important!
The Australian tax model for dividends differs from other countries; these require investors also pay tax on dividends above and beyond the corporate tax.
While there are no limits to franking credits, there are conditions the Tax Authority have created. Taxpayers must hold “at risk” shares for a minimum of 45 days (which, with the 2-day purchase period, equals 47 days).
Important!
Familiarise yourself with other conditions on the Australian Government Taxation Office website.
What Can Be Done With Dividend Payments?
Depending on the dividend payment structure of a company, investors have a few options when handling dividends.
1. Dividends As Shares.
Some companies treat their dividends as shares rather than cash payouts on profits. This allows companies to invest internally (or into another venture) while making a dividend payment.
In this scenario, an investor receives additional shares equivalent to the value of a dividend payout in cash.
2. Dividend Reinvestment Plan.
Some companies allow investors to opt for more shares instead of receiving cash payouts of dividends. An investor opts for this before the payout, and the payout is in the form of additional shares.
You can reinvest in two ways:
- Automatically reinvest using an online share broker.
- Automatically reinvest using a dividend reinvestment plan.
Opting to reinvest a dividend does not usually incur a brokerage fee.
3. Exchange-Traded Funds (ETFs) and Dividends.
ETFs are investment funds that pool money from multiple investors to invest in a diversified portfolio of assets like stocks, bonds, and commodities.
ETFs may also use a dividend reinvestment plan to compound returns over time and offer tax advantages through “stock swapping“.
Important!
Pay attention to the specific dividend policies, expense ratio, and management fees of any ETF you consider.
4. Dividend Cut.
When a company has a worse-than-expected performance or incurs unanticipated expenses, companies will cut dividends in a necessary effort to maintain liquidity.
While all companies fluctuate in dividend payouts, cutting dividends results in a company’s share price falling.
5. Dividend Harvesting.
Some investors hold onto their shares in a company to qualify for a dividend payout before selling – a process known as “harvesting.”
The risks with harvesting are:
- Share prices usually fall on the Ex-Dividend date.
- If the stock falls more than the dividend paid, this can cut your net profit.
- You often need to wait for the stock to return to the purchase price before you sell, which is not always guaranteed.
6. Dividend Trap.
A dividend trap is when a company’s stock has a high dividend yield that lures investors into buying the stock solely for passive income.
However, the dividend may not be sustainable or at risk of being cut.
Example.
In 2019, Australian construction company Boral Limited had a dividend yield of around 10% but had declining earnings and a high level of debt. After concerns regarding the sustainability of its dividend, Boral announced a significant cut to its dividend.
For Australian traders and investors, it’s essential to avoid falling into the dividend trap by solely focusing on a stock’s high dividend yield.
Instead:
- Evaluate the company’s financial health.
- Research company growth prospects.
- Pay close attention to the company’s debt levels and market conditions.
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Dividends vs Capital Gains.
There are significant differences between dividends and capital gains.
| Dividends | Capital Gains |
|---|---|
| Periodic payments companies make to shareholders as a distribution of profits. | Profits made by selling an asset for more than its purchase price. |
| Provide a steady income stream for investors. | Provide a one-time windfall. |
| Are paid out of a company’s earnings. | Are typically generated through market appreciation. |
| Often associated with more stable, mature companies with consistent earnings and dividend payments. | Are associated with growth stocks that have the potential for significant price appreciation. |
| Usually taxed lower than capital gains, making them an attractive option for income-focused investors. | Are taxed at different rates, depending on the timing of the asset and the investor’s tax bracket. |
| Can vary depending on the investor’s tax bracket and when the asset was held. |
Important!
Short-term capital gains (assets held for less than a year) are generally taxed more than long-term capital gains (assets held for more than a year).
Final Words About Dividend Investing In Australia.
Dividend investing turns can appear intimidating at first.
Unlike regular share investing, which many Australian investors either do on a whim or by spotting market trends, dividends demand a reasonable level of fiscal and business literacy.
Take time to understand these concepts and remember that these barriers to entry act as filters, weeding out or tripping up short-sighted or non-savvy investors.
The more you know, the more competitive advantage you have in the market – and the more successful your dividend investing strategy will be.
Steven
Nelson says:
I attempted to use the “hack” to dodge conversion fees, but sadly after converting AUD to USD on a Wise account, there doesn’t seem to be a way to deposit that money into eToro; i.e. eToro recently disabled Wire transfers and Wise doesn’t support SWIFT transfers for sending USD to a bank in the US?
John Keys says:
CMC Invest are an abysmal in turning around new accounts.
Over 1 month to setup up an account with an investment trust, and still waiting. I was promised 5 business days.
Reg Watson says:
Given that China’s economy is going down the toilet how the heck do we expect an appreciation of the Aussie in 2024 ? We are tied to China.