What are share dividends and why do they matter?

Shaun Port
on
Reading time: 2 minutes

In short, dividends reward shareholders by giving them a cut of the company’s profits. But there’s more to it than that. They can be of great benefit to portfolios in the long-term, especially when re-invested – that’s why they form a crucial part of our investment management strategy at Nutmeg.

In the second quarter of this year UK companies paid out the largest ever share dividend, totalling £25.3bn. US firms are also keen to reward their shareholders – 92 of them, including Coca-Cola, Walmart and Procter & Gamble, have increased their dividends for 25 or more consecutive years. But why are these dividends so important and how can they be best utilised by investors?

Explaining dividends

Dividends can make up a large chunk of the return you can get from investing in a company and for that reason are seen by many investors as a key reason for owning stock. On the flip side, a high dividend in relation to the price of a company’s stock (known as the ‘dividend yield’) can serve as a warning that the company’s share price might be depressed for some reason, or that the dividend will be cut, so it acts as an indicator of a company’s future growth prospects.

Dividends are also remarkably stable, especially compared to the volatility of actual share prices.  In the years since the Second World War, US companies have reduced the dividend they pay on only seven occasions, while growth in dividends has outpaced inflation in two out of every three years.

 Historically, UK companies have paid out a much higher dividend than the US. The current dividend yield for the UK market is 3.6%, which is about average for the past 30 years, compared to 2% in the US.

Re-investing dividends                      

Re-investing dividends has also been a really powerful driver of stock market returns. The graph below shows the staggering difference between an investor who re-invests dividends to one who doesn’t. Investing £100 in 1970 would now be worth £140, without re-investing the dividends – that’s after inflation is taken into account.  But when re-investing those dividends back in to the market, that £100 would be worth an incredible £827 (again, after inflation).  Put another way, the annual compound return for UK equities with dividends re-invested was 5.0% per annum after inflation, but just 0.8% p.a. without dividends.*

Even recently, while the UK stock market is still 3% below the level we saw before the financial crisis, with dividends re-invested the total return since June 2007 is in fact +22%, beating cash returns over the same period**.

Dividends are a cornerstone of our investment management strategy at Nutmeg. The vast majority of the funds we invest in for Nutmeg customers pay income – that is, dividends from equity funds and income from fixed interest funds.  These dividends are automatically re-invested back in to our customers’ portfolios in our monthly rebalancing process, without any extra charge.

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Risk warning

Capital at risk. The price and value of investments mentioned and income arising from them may fluctuate. Past performance is not an indicator of future results, and future returns are not guaranteed.

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Sources:

Capita Registrars
Capita UK Dividend Monitor Issue 16, July 22nd 2013
Financial Times Investors Cash in on UK dividends boom October 26th 2012
Bloomberg, 30/7/13
*Nutmeg calculations using data from Macrobond based on MSCI UK indices.  Figures exclude fees but are net of withholding tax on dividends.
**Nutmeg calculations using data from Macrobond, MSCI UK indices, Bank of England data on average ‘sight’ deposit rates and the Consumer Price Index. The return on cash deposits was 9.0% compared to a 19.9% gain in consumer prices

Shaun Port

Shaun Port

Shaun is the chief investment officer at Nutmeg. He has over 25 years’ experience developing and implementing investment strategies for clients ranging from central banks to pension schemes to charities and private individuals. Shaun holds a degree in Mathematical Economics from the University of Birmingham and is a Chartered Alternative Investment Analyst. He can be found tweeting @ShaunPort.

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