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What is dividend

Dividend is distribution of a company’s profit to its shareholders, at the discretion of company directors. It is not mandatory for a company to pay dividend to shareholders.

Dividend is deemed as a reward from company to shareholders for putting their money in the company. Normally profit is partially distributed as dividend when a company believes that there is no better use of the money for the good of business. In other words, companies that pay dividend are normally more established companies. On the other hand, companies that are still experiencing rapid growth would rather to save the earning for further expansion rather than dividend distribution.

Basics: dividend investment terms and ratios

Dividend per share (DPS)

Dividend per share (DPS) = Dividend in sens distributed over a period of time per unit of shareholding, typically past 12 months.

Dividend yield (DY)

Dividend yield (DY) = Dividend per share (DPS) / Share price. Dividend yield is a dynamic number that will fluctuate with share price. All trading platforms and stock websites will have dividend yield calculated automatically for investors.

For me, I always manually calculate and check dividend yield again based dividend history. Why? There are three reasons.

• If company has distributed a special dividend in the past 12 months, it should be excluded for prediction of future dividend.

• If company has any upcoming corporate exercise that will significantly affect the number of shares such as private placement and right issue, the dilution effect should be considered in prediction of future dividend per share (DPS) and dividend yield (DY).

• Different platforms could have the dividend yield calculated based over different timeline. Some platforms calculate dividend yield based on the past financial year, whereas some calculate based on trailing four quarters.

Dividend payout

Dividend payout = Percentage of net income distributed as dividend.

Is high payout ratio always good? The answer is no. I would want company to maintain a healthy dividend payout ratio, so that I can have some dividend income without compromising growth potential of the company.

There are some companies that are even providing more than 100% payout, i.e dividend distributed is more than profit earned. This is definitely not a good thing, because this is not sustainable over the long term and it also implies limited growth potential of the company.

How much is healthy dividend payout ratio? Unfortunately there is no magic number, but in general I am comfortable for range between 20% to 50%. Note that REIT (real estate investment trust) is an exception, which typically has more than 90% dividend payout.

Dividend policy

Dividend policy is policy set by company with regards to its dividend payout ratio and distribution frequency. Dividend policy is at full discretion of management, and not all companies have dividend policy.

Divided policy is a good guideline for investors to predict future dividend. In addition, company with dividend policy tends to provide more consistent dividend.

Dividend policy of a company can be found from annual report.

Interim dividend, final dividend, special dividend

Interim dividend is declared by company along with interim quarter report

Final dividend is declared by company after issuance of full year financial report. In other word, this is the final dividend in a financial year.

Useful tip: It is not mandatory for company to distribute final dividend. It is possible for a company to declare interim dividend but no final dividend.

Special dividend is dividend declared by company on top of typical recurring dividend. Reason for special dividend could be company making much more profit than usual, or company has sold an asset for a one-time capital gain.

Why dividend investing

In the word of stock investment, there are only two ways to realize profit – dividend and selling stocks for capital gain. From my observations, for investors who opt for dividend investing strategy, the ultimate goal is always building enough passive income for financial independence and retirement. 

For people like me who hope to build a share portfolio for financial independence, understanding dividend investment is a must. As mentioned, there are only two ways to realize profit from stock market, getting dividend payment and selling share for capital gain. It is not feasible to sell shares every month to pay for bills, right?

For myself personally, it is so hard to figure out how much asset I actually need to financially secure my future. There are so much assumptions required, such as life expectancy, lifestyle, travel plan etc. On top of that, whenever there is a big life event like getting marriage and having kid, the whole calculation is just not right anymore. Not to mention that some basic financial knowledge is required to adjust for the effect of inflation.

On the other hand, I believe most of the people can tell much quickly how much is required to sustain life. Even say there is a life changing event, figuring out how much extra monthly income required is still much easier. In this regard, dividend investing fits perfectly.

Dividend stock vs growth stock

Dividend stock vs growth stock, a common question asked by many. I do not think there is a definite answer whether one is better than the other. Ultimately, anything that can make money is good.

But what I would like to point out is, ignoring growth when making dividend investing would be a big mistake. Think of dividend as a passive income to replace active income (e.g. salary). We all want to have salary increment every year, and we should have the same expectation on the passive income also.

In other words, a successful dividend investing portfolio should provide dividends that can grow automatically every year. With growing dividend, the share price will also grow in tandem over the long term.

In summary, there are 3 engines available for us to grow financially with a company – dividend yield, dividend growth and share price growth. For good growth stocks, it shall grow with a big share price growth engine. For good dividend stocks, it shall grow with all three small engines.

Risk of dividend investment

Companies that pay consistent dividend are normally more established companies. So there are many people think of dividend stocks as a safe and reliable investment.

Warren Buffet once said “risk comes from not knowing what you are doing”.

Misconceptions on dividend stock investment are the biggest risk. Below I have named three common misconceptions.

• Assuming it is risk free. No investment is risk free. Investors who ignore risk of dividend investment and let the guard down, can potentially be badly hit.
• Dividend companies are more stable. While dividend stocks are relatively more established companies, it does not mean it will not go down in the future. Closely monitoring and reading of the latest news and financial results are required, just like investing in growth stocks.
• Blindly pursue high dividend yield. As mentioned above, a successful dividend stock needs three small engines (dividend yield, dividend growth, share price growth). It is required to evaluate dividend stocks from all three aspects. Otherwise, a broken share price engine can easily take away all the effort from dividend engine.

Dividend calculator

There are many calculators available online, and it can be easily done through excel also. To recap, successful dividend investing should utilize all three engines (dividend yield, dividend growth and share price growth). So whether you are looking for online calculator or build one yourself, please ensure to factor in all of these three engines.

For reference, here is one online calculator that I find it useful.

Dates you need to know about dividend

Announcement date

Date that company management makes announcement on dividend distribution.

Ex-dividend date

Eligible date which shareholders can entitle for dividend. To entitle for dividend, investors must be holding the shares BEFORE Ex-dividend date. Two common question about ex-dividend dates

• Do I entitle for dividend if I buy the shares on Ex date? – Answer: No.
• Do I still entitle for dividend if I sell my shares on and after Ex date? – Answer: Yes

Entitlement date

Entitlement date is the date on which a company checks its records to see who should receive the dividend. Another name of entitlement date is record date.

In Malaysia, after a share order is matched, shares will be credited into buyer’s account after two working days (hence the term “T+2”). In other word, only two days after a matched order that your name will be recorded in system as shareholder.

The ex-dividend date is developed to assist investors to take account of “T+2” effect. For example, a company decides to check its record on 4th Jan for eligible shareholders for dividend payment. For investor to entitle for dividend, the last day to place an order will be 2nd Jan. In this instance, 3rd Jan is ex-dividend date and 4th Jan is entitlement date. Because of “T+2” trading system, entitlement date is always one working day after ex-dividend date.

Investors should not be concerned about entitlement date, ex-dividend date is much more important and meaningful.

Payment date

Actual date that dividend is paid to eligible shareholders. Note that for nominee accounts, brokers might only transfer dividend to shareholders few days after payment date.

Is it wise to buy before Ex-date of dividend?

Theoretically, it does not make a difference. After dividend is paid, the portion of asset is going out from company so share price should decline in proportion.

For instance, a company with share price of $1 announce dividend of $0.05. On dividend ex-date, share price would drop by $0.05 to reflect that portion of capital leaving company’s book.

However, theory does not always reflect in reality. I have seen many investors like to purchase stocks after announcement and before ex date to enjoy the dividend. This gives a false impression to investors that they are getting “cash rebate“ for their stock purchase.

On the other hand, many investors that are already holding a company’s shares will likely not to sell the shares before ex date. For these investors, selling before ex-date means a waste of dividend.

So imagine what will happen with above? Generally buying pressure will build up after announcement date and before ex date. In contrast, selling pressure will increase on and after ex date. As a result, I’ve seen it quite often that share price declines to greater extent that dividend amount on and after ex date. Of course, dividend distribution is just one of the factors affecting movement of share price, judgment should be made on case by case basis.

Back to the question whether should buy shares before ex-date to get dividend. It depends on many factors. Personally, if I see potential of a company, I would invest earlier than dividend announcement date at the right price. Otherwise, I would wait until after ex-date as I could potentially get a bargain on the share price.

 Dividend distribution frequency

Depending on company, dividend can be distributed quarterly, half-annually or annually. There are also companies that do not have dividend policy, meaning there is no fixed dividend pay-out schedule.

I do not think dividend distribution frequency should be a factor to consider while deciding whether to invest in a company. Having say that, more frequency dividend distribution can benefit investors in two ways.

• From the aspect of time value of money, money received earlier is more valuable than money received later. The earlier the dividend is received, the earlier you can make use of it for other purposes, such as reinvest.
• From the aspect of building passive income, more frequent dividend income gives you more stable passive income stream to pay your monthly bill.

What is dividend reinvestment plan (DRP/DRIP)?

Sometimes when a company declare a dividend, management will provide investors with options whether want to receive cash dividend or share dividend. You can also chose to receive certain partial amount of cash with the remaining received as shares. This is dividend reinvestment plan.

In Malaysia, if you did not inform company that you want share dividends, by default you will receive cash dividend in full.

Useful tip 1: In Malaysia, minimum share transaction quantity is 1 lot (100 shares). So when I opt for dividend reinvestment plan, I normally round down to hundreds. For example, if I’m entitled for 1543 of shares, I will select maximum 1500 shares. Otherwise in case I want to sell the shares, the 43 shares cannot be traded.

Useful tip 2: In older days, I used to receive physical forms from company for dividend reinvestment plan. To opt for share dividend, I need the fill the form and send it over through post. Nowadays, with registered tricor online, so the process can be done online with little handling fee. Another good thing with tricor online is, I will receive email notification about dividend reinvestment plan that I’m entitled for. This is good for me because sometimes I just don’t check my physical mail box so frequently. Here is the link to tricor online.

Is dividend reinvestment plan good or bad?

In general, it is beneficial to both investors and companies.

For investors, you can reinvest in the company without paying typical transaction charges (brokerage fee and clearing fee). In addition, DRP is offered at a discount price to market share price. For instance if the share price is $3, dividend reinvestment plan may offer to use dividend to buy shares at $2.80.

Useful tip: While it is typically for companies to set dividend investment plan based on discount market, I’ve seen the case whether market price drops below DRP price. For instance based on example above, initial market price is $3 and DRP offered price is $2.80. However before due date of DRP, share price drops to $2.60. So always compare with the latest market price before making decision.

For company, with dividend investment plan, company is not paying actual cash as dividend so the cash can be conserved for other business purpose. Company only need to adjust equity statement accordingly.

But is there a cons? Yes. Dividend investment plan means share dilution (i.e. increase number of shares), and any form of share dilution will always put share price of a company under pressure.

Stock dividends

In some cases, companies will distribute dividend as stock dividend instead of cash dividend. Stock dividends means the dividend are paid to shareholders as number of new shares rather than cash. It has some similarities with dividend reinvestment plan explained above. The difference is, in dividend reinvestment plan, shareholders have the options to choose between cash dividend and stock dividend.

Similar to dividend reinvestment plan, stock dividend also has the disadvantage of share dilution effect.

Do we need to pay tax for dividend income?

Malaysia is under single tier tax system. Under single tier tax system, tax already paid by company is final and no tax will be deducted from dividend paid to shareholders. Investors do not need to declare dividend income in tax filing.

For more information, please refer to official government website here.

Please note that tax exemption mentioned above is only applicable to stocks in Malaysia market. If you are investing in foreign market, it depends on the laws on that country. For instance,

• For US stock market, dividend income will be subject to flat non-resident withholding tax rate of 30%. For clarity, withholding tax means company will withhold/deduct the tax before dividend is paid to shareholders.
• For Singapore stock market, single tier system is applied so dividend income is not taxable.

Special case: Tax for real estate investment trust (REIT)

For REIT in Malaysia, the situation is different. As long as REIT is distributing at least 90% of income as dividend (which I believe is the case for all REITs), REIT company does not need to pay corporate income tax. Instead, 10% withholding tax will be deducted before dividend distribution to shareholders.

In summary, whether single tier system for stocks or 10% withholding tax in case of REIT, shareholders investing in Malaysian stocks do not need to worry about tax. Dividend received from Malaysian stocks is net, shareholders do not need to pay additional tax on the dividend income received, and it is not required to declare in income tax filing.

Dividend investing strategy – how to succeed?

I have mentioned above in the section comparing dividend stocks vs growth stocks, but I would like to emphasize again. Buying a dividend stock purely for its high dividend yield is a BIG NO. For good dividend stocks, it shall grow with three small engines (dividend yield, dividend growth and share price growth).

Dividend yield

As an investor that wants to build passive income from dividend portfolio, dividend yield is definitely first thing that will come to mind. High dividend yield is not necessarily good. For a stock having a high dividend yield but not performing better every year, the loss in share price can easily take out all the dividend earning.

Personally, to categorize a stock as dividend stock, I would benchmark using 12 months fixed deposit rate. For me, any stock with dividend yield higher than at least 1.5% of 12 months fixed deposit rate can be categorized as dividend stocks.

Dividend growth

Ideally, I want dividend stocks to always pay same or more dividend compared to the previous year. Whether a company is paying more dividend over years can be easily found from dividend history.

What happens if company pays less than previous year? That is not desired but don’t make judgement too soon. In this case, I would dig in to understand more before making a judgement whether this is a good dividend stock to invest.

There two reasons that I can “forgive” company for paying me less dividend

1. Company is preserving cash for business expansion and development. If I think the business plan is workable and will bring me more dividend in the future, less dividend than previous year is acceptable to me.
2. Company is experiencing event beyond control, but the event is not going to be long term. One good example is COVID-19 pandemic in 2020. Earning of many dividend stocks was badly deteriorated and therefore dividend distribution is less. As long as fundamentals of the company remain intact, this is acceptable.

If a stock pays less dividend because their business is losing competitiveness, losing market share and/or profit margin compression, then it is the time to switch to other stocks.

Share price growth

Share price goes up and down, but over the long term it will always hover around its actual worth. What determines actual worth of a company is its earning.

As long as earning per share (EPS) is growing, over long term the share price will go in tandem. Note mention that with EPS growing, it is very likely the company will distribute more dividend. So a good dividend stock shall have earning per share (EPS) continue to grow every year.

Useful tip: Many corporate exercises can increase number of shares and dilute shareholding (e.g. private placement, dividend reinvestment plan, bonus issue, right issue etc.). Therefore always refer to earning per share (EPS) instead of total net income.

Consistent dividend payment

For dividend investing, I want the dividend distribution to be consistent. To know this, easiest way is just to check dividend history. In addition, it is also worthwhile to check whether the company has a dividend policy, which can be found from annual report. Company with dividend policy tends to pay dividend consistently.

Buying price is a key

For any kind of investing strategy, buying price is always a key, dividend investing is no exception. Unfortunately there is no simple way to calculate whether share price of a stock is undervalued, otherwise no one will lose money in share market.

However there is a simple screening method as preliminary evaluation. That is to check current P/E (price over earning) of a stock over its average P/E for past five or even 10 years. If it is traded below average, there is a chance that it is undervalued. Of course, this is assuming that earning per share (EPS) is still growing.

Fundamentals of company

As mentioned above, there is no simple way to calculate whether share price of a stock is undervalued. To truly evaluate a company, the only way is to get down to basics and understand fundamentals of a company.

Knowledge about fundamentals of a stock can easily be book, so I will just skip in this article. If you are looking for good books to learn how to evaluate fundamentals of a company, you can refer to my recommended books here.

Compound interest – 8^th wonder of the world

Albert Einstein is reputed to have said “Compound interest is the eighth wonder of the world”. To leverage on compound interest, it is a must to use dividend received to reinvest.

You might think “what? I want to use dividend as passive income to pay my bills, then what’s the point?” Dividend investing takes time to succeed, so it is required to continue building it until a stage that it not only enough to pays your bill, but also has extra that can be reinvested. For me, that is the point of reaching financial freedom for dividend investor.

End

Dividend investing takes time to see results and that’s why many investors are not interested. There are other stock investment strategies that also work. But to have consistent passive income from stock market, there is no other way than dividend investing.

Who says one can only stick with one investing strategy? In my opinion, the best effective way is to continue growing your active income (e.g. salary) and other investments, while building dividend stock portfolio in the meanwhile. Doing it consistently from early age and the day will eventually come when dividend income can become main source of income, i.e. financial freedom!

To build my dividend stock portfolio, I am always looking for potential dividend stocks in Malaysia stock market. My analysis and view on these dividend stocks can be found in the link below. Note that these articles are purely my notes from studying those dividend stocks. This is not a BUY or SELL call. Please be reminded that you should invest at your own risk.

Extended reading: Analysis of dividend stocks in Malaysia