Money and plants

Picture holding shares in Australian companies like BHP, Commonwealth Bank, Wesfarmers, or Woolworths. As a shareholder, you have the right to receive a share of the company’s profits in the form of regular payments, commonly known as dividends. Companies distribute dividends as a way to reward shareholders and allocate portions of their profits or surplus cash that are not being reinvested back into the business operations.

The Power of Dividend Reinvestment Plans (DRP)

As a shareholder, you’re given the choice to either receive these dividends as cash payments or to reinvest them into additional company shares through a Dividend Reinvestment Plan (DRP).

Choosing to reinvest your dividends can significantly amplify the growth of your investment over time. This is due to the power of compounding, where the dividends that are reinvested earn dividends themselves. When combined with continual contributions and a long-term investment perspective, this can substantially enhance the value of your investment.

Future Capital Gains

By opting to reinvest your dividends, you’re essentially acquiring more shares. If the share price of the company increases over time, this can result in considerable capital gains for your investment.

Dividend payments from the top 100 companies generally tend to grow along with their profits over time, offering a potentially stable income stream for investors.

Listed Companies' Profits and Dividends

https://www.rba.gov.au/publications/rdp/2019/2019-04/australian-equity-market-facts-1917-2019.html

Selecting the Ideal Dividend-Paying Shares

While many companies listed on the ASX offer dividends, it’s worth noting that not all do. When considering an investment in dividend-paying stocks—or any type of investment, for that matter—comprehensive research and due diligence are crucial. Here are some key factors our advisors recommend considering:

  1. Financial Health of the Company: Scrutinize the company’s financial stability by examining key metrics such as consistent earnings growth, manageable debt levels, and robust cash flow.
  2. Track Record of Dividends: Investigate the company’s history of dividend payments. A consistent history of paying dividends and evidence of growth in these payments suggest a stable and shareholder-centric approach.
  3. Assessing Dividend Yield: The dividend yield is the ratio of the annual dividend per share to the current stock price. While a higher yield may seem attractive, it’s important to evaluate this figure in the context of the company’s overall performance and industry benchmarks.
  4. Dividend Payout Ratio: This ratio represents the portion of the company’s earnings that is distributed as dividends. A sustainable payout ratio indicates that the company can maintain its dividend payments without hindering future growth.

Diversification

Two key strategies for diversifying dividend-paying shares include building a diversified portfolio and considering dividend ETFs or managed funds. Diversifying your portfolio across various sectors minimizes risk and can improve returns, offering a steady stream of passive income tailored to your financial goals. If individual stock selection seems daunting, dividend ETFs and managed funds offer a convenient, lower-risk alternative. These funds pool investments to create a diversified portfolio of dividend-paying stocks, eliminating the need for extensive individual research.

Understanding Franking Credits

Franking credits are tax credits that Australian companies pass on to their shareholders along with dividend payments. They are essentially a way to avoid double taxation on dividends, first at the corporate level and then at the individual level.

In Australia, the company tax rate in Australia is 30%.

Example:

Let’s say BHP pays you a fully franked dividend worth +$1,000.

To pay you the $1,000 fully franked dividend, BHP must earn $1,428.57 before tax.

This means BHP has already paid $428.57 tax on your $1,000.

The franking (tax) credit attached to the dividend is $428.57.

Franking can be powerful but the total benefit will depend on your tax bracket:

Tax Rate(r)Gross dividends(d)Franking credit(c)Tax((d+c)*r)Net(d+c-tax)
15%$ 1,000$ 428.57$ 214.29$ 1,214.29
30%$ 1,000$ 428.57$ 428.57$ 1,000
40%$ 1,000$ 428.57$ 571.43$ 857.14
50%$ 1,000$ 428.57$ 714.29$ 714.29

This is not tax advice. Numbers may vary depending on the financial circumstance of the entity. Consulting a tax professional can further help you understand how to optimise these credits based on your specific financial situation.

iInvest Example of Managing Dividend Income

In 2022, we advised our clients to re-evaluate their holdings in TLS. For instance, we recommended selling Telstra (TLS) and transitioning to Fortescue (FMG). The reason behind this move was Telstra’s substantial drop in dividend yield, dropping from approximately 7% to 3%.

To better understand the impact of this decision, let’s take an example. Imagine you had invested AU$ 20,000 in Telstra, which would have generated roughly AU$ 700 in dividend yields. However, by following our advice and reallocating your investments to FMG, you would have achieved a notable increase in returns. Despite holding fewer FMG shares, your dividend returns would have surged to AU$ 2,200.

Dividends-comparison-between-Telstra-and-Fortescue

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