What are dividends and how do they work ?

So what exactly is a dividend, it can be seen as most of the most important parts or reasons to invest within a specific or certain stock or company.

Firstly, let’s explain what exactly a dividend is ?

A dividend is a portion of the company’s profits or earnings paid out to an investor, that owns a share in that respective company. A dividend can be paid out quarterly, but most companies will pay an interim dividend based on half-year results and a final or annual dividend based upon total profits for that year of trading.

They will be pad out in cash to the appropriate shareholder, or they could be given out as new shares in the form of a scrip dividend. Or something called dividend re-investing.

Why do companies pay out dividends !

When a company is making profits, it has several choices of what it does with the money.

• It could reinvest the funds to grow the business for future growth.
• they could cancel or buy-back shares to increase investing ratios.
• or it could distribute earnings to shareholders, i.e dividends.
• If a company appears attractive of has a good yield, then it will attract investors.

The dividends and payout rates will be published each time a company issues quarterly, half-yearly or annual results, to regular specific dates or timetable.

It may even pay out a special dividend as a one-off event. If it has sold a business and has free additional cash. Or as some part of restructuring programme.

Why may a company not pay a dividend to investors !

It could be in the early years to trading and may be using all profits and earnings to re-invest back into he company so it can grow faster.

Or it could be reduced or stopped as a short term measure as the company could be struggling financially, so it many be unaffordable.

The company could be losing money and may not unable to afford to pay out a dividend.

What are the benefits of receiving dividends !

It can be seen as free money from a company in return for investing in that company.

At present in the UK the FTSE 100 (so top 100 listed shares) are paying an average yield of just over 3%, which could be higher than holding cash in a savings account. Larger and more established companies have a much more stable track record when paying out dividends.

If re-invested over many years the power of compounding could improve your portfolio value dramatically in future years. They can be seen as a great tool to build long term growth.

If invested in a tax-free wrapper such as an ISA or pension, any dividends you receive are considered tax-free. So avoid the need to pay any dividend tax. Also their is no need to declare them to HMRC via self-assessment.

So how do stock dividends work !

• Firstly a company will have to make money, based on it’s trading or earnings.
• It will then decide an appropriate amount to be paid out per share.
• At specific dates, it will paid distribute the money to shareholders.

They will be paid on a per share basis, so the number of shares an investor holds the bigger payout they will receive.

Simple example: If an investor hold 100 shares and the company pays out 5p per share, they should then receive £ 5 on the dividend payment date.

How often are dividends paid out !

Dividends can be paid out quarterly, semi-annually and annually. Dividends paid out at half-yearly are called interim dividends. With the final dividend known as final or full year. The annual dividend is normally a larger payout than the interim dividend.

Be aware that dividends are not set in stone, although they will normally be increased year on year. If a company is struggling financially it could be kept at same level, suspended or even stopped for a short period. This could be seen as a bad move for the option, which could result in loss of confidence with investors, or a fall and collapse in the share price. As the future prospects of the company may not look as rosy or promising.

What is a scrip dividend !

Instead of being out a dividend in cash, they could pay out in the form of free shares. A company may give you a choice as an alternative. which allows you to increase the holding within that company.

What is dividend re-investing !

This can be one the most rewarding things you do as an investor to substantially increase your portfolio value. Figures have shown on regular basis, that investing additional of free money into your portfolio will vastly speed up the process of increasing your portfolio over time.

So how do it work: Quite simply your dividend will be paid to you in cash into your holding account. They will invest very soon after, normally 2 days later, your platform will re-invest that amount into buying more shares into the company that just paid you a dividend. It will cost you a small fee, but my current SIPP & IS provider (https://www.ajbell.co.uk/) charge me £ 1.50 per trade plus stamp duty of 0.5% per trade.

By doing this, on the next payment date, as I own more shares I will receive a bigger payout as I own more shares. Along with the fact that dividend payment rate may also be increased. So it acts as the wonderful power of compounding.

What about dividends when buying funds or ETF’s

Dividends could also prove very beneficial when investing in funds os simple ETF’s. You may buy fund for growth reasons but they will normally payout a small % to investors as dividends to attract them to invest in that specific fund.

You may pick a global fund for growth or you may invest in an income fund solely for income to be paid out to you.

If you buy income based units, the fund will pay out an income to you on a set date, as per the payout rate and the timetable. You are then free to invest however way you wish in future.

Or you may buy accumulation units, in this way any payout you receive will be automatically invested in that fund. So you don’t exactly receive a payment amount, but the price of the units will be increased to reflect the dividend reinvestment back into that fund. Again, it can be a great way to increase holding in a fund over time through the power of compounding.

Most platform provider will have a list of funds they recommend, based upon sectors, income payouts. All dependent upon your risk profile, investment objectives and long term investment aims. So use the free tools on offer via your providers website if you are new too investing. Or you may be a seasoned investor investing for a specific reason.

What is the company dividend issuing process !

The process to pay out a dividend can be seen as somewhat complex and will handed by the company’s registrar to an agreed timetable.

• Declaration date – the date of the results or announcement that a dividend is going to be paid. So it will announce ex-dividend and payment date.
• Ex-dividend date – The date that a buyer is eligible to receive upcoming dividend, they have to own the shares ahead of that date. If a buyer buys a share after this date, they will cease to be ineligible to receive next dividend payment. If you sell your shares after the ex-dividend date you will still receive the payout as your were a shareholder on that specific date.
• Record date – This is where the company will see who actually owns the shares on its register. it is normally the day after the ex-dividend date.
• Payment date – This is the actual date that payments are paid to shareholders. Most companies now will pay dividends directly to your nominated band account or trading account. It may not be credited into your account that date, it could depend upon the distribution of your platform provider. In the past, most companies would have issued cheques to the client, but it now a much simpler process.

What is dividend yield !

The dividend yield can be seen as a simple metric to evaluate a company. They normally use somewhat called a “trailing dividend yield”, as it will state the amount paid out in the previous 12 month period as a % figure. So if a company was priced at 500p at share and the dividend was 10p per share – the yield would be 2%.

These past numbers used should be seen as an indicator if a company appears attractive to invest in. How do it compare to the market as a whole, or other companies in that sector. Are dividends being increased year on year, is the yield figure increasing or does it remain static.

What could be considered good yield !

At present the yield of the FTSE 100 is 3.34% (as of July 2025), so anything above average could be seen as enticing or attractive. But it all comes down to the companies ability to maintain and grow that payout in future years.

A company may have a very high yield, due to a reduction in recent share price in recent months. Or if a company has a very low yield, it could be avoided by investors who are looking for larger payments to generate decent level of income or increase the value of their portfolio.

List of current largest shareholders in FTSE 100 (from http://www.dividenddata.co.uk)

EPIC	Name	Sector	Market Capital (m)	Annual Yield ▼
WPP	WPP	Media	£4,535.29	9.37%
TW.	Taylor Wimpey	Household Goods and Home Construction	£3,852.98	8.69%
LGEN	Legal & General Group	Life Insurance	£14,547.1	8.44%
PHNX	Phoenix Group Holdings	Life Insurance	£6,533.49	8.29%
MNG	M&G	Investment Banking and Brokerage Services	£6,209.33	7.78%
LAND	Land Securities Group	Real Estate Investment Trusts	£4,302.05	7.00%
RIO	Rio Tinto	Industrial Metals and Mining	£54,500.11	6.91%
BATS	British American Tobacco	Tobacco	£83,783.86	6.29%
LMP	Londonmetric Property	Real Estate Investment Trusts	£4,528.84	6.21%
BP.	BP	Oil, Gas and Coal	£63,118.85	6.01%
AV.	Aviva	Life Insurance	£19,295.78	5.66%
SDR	Schroders	Investment Banking and Brokerage Services	£6,265.67	5.53%

What is dividend cover !

Dividend cover is a simple investing equation that calculates how sustainable a companies dividend payments are to shareholders.

To calculate: simply divided the a company’s profit by the value of its dividend payments.

So if a common makes £ 1,000,000 in profits but pay out £ 500,000, it has a dividend cover of 2. If the dividend can be seen as comfortable and affordable it can be seen as good sign as it is paid out from profits or earnings. If the dividend cover is low and unaffordable it should set alarm bells as it cannot be guaranteed or sustainable in future. It will likely be cut or reduced in the short term.

Dividend payout ratio:

This metric is just as important, but can be neglected by the average investor. It shows how much is paid out in dividends against its profits.

To calculate: we divide the total amount of dividends paid out against its net income.

So if a company has made £ 1,000,000 in profit and paid out £ 500,000 the we have a payout ratio of 0.5%

How are dividends taxed !

If shares or funds are held within an ISA or pension, they will remain dividend tax free.

If shares are held in a general investment account outside a tax free wrapper, then dividend tax will become payable by the holder. If is normally declared through self-assessment by most people.

You will then be taxed depending on your income received during the tax year.

For 2024/2025 tax year:

• Basic rate UK tax-payers: 8.75% over dividend allowance of £ 500
• Higher rate UK tax-payers: 33.75% over dividend allowance of £ 500
• Additional higher tax-payers: 39.35% over dividend allowance of £ 500

These rates can change each year, so it pays to invest any funds within a tax-free wrapper. You have an annual free allowance of £ 500 so use it to your effect. It will save unnecessary expense to you and will reduce your admin so you don’t have to complete self-assessment or declare in future years. It may be that your dividend amount in the first year is a small amount when starting out but through the power of compounding a portfolio. That sum of £ 500 could be reached very early if you are investing large sums on regular basis.

Key points and takeaways:

• Learn to put all shares and funds in a tax-free investment wrapper.
• remember to re-invest all dividends to grow your portfolio through compounding
• Do background research in a company ahead of purchasing, are dividends affordable and sustainable, are they increasing year on year.
• Does a specific yield look too low or excessive, can it be maintained.
• Use your £ 500 dividend allowance to your advantage.

Remember:

If you liked this blog post and found it useful and informative, check out my other posts on https://moneyminted.co.uk which covers savings, investing, pensions and investment books that I recommend. So you too can improve your investing knowledge, financial education, so you too can reach your investment goals and aims.

It’s not a get rich quick scheme but you will get there in the end if you create a plan and thing long term !