Investing in Dividend Shares - The Definitive New Zealand Guide
Our guide explains what a dividend share is, the pros and cons of dividend shares, top dividend shares and Frequently Asked Questions.
Updated 8 August 2024
Summary
Our guide explains what you need to know about dividend shares to make an informed investing decision. We cover:
Summary
- Dividends can be a wonderful source of passive income to supplement your retirement or to provide additional cash to meet day-to-day expenses.
- Dividends are known for their consistent, stable returns and are a great option for many investors today. But with hundreds of different dividend shares, how can the average New Zealand investor separate the great dividends shares from the average? Our guide links to top dividend shares.
- Dividend shares are not without their risks and have burned many uninformed investors. A failing share price will boost the dividend yield (percentage return), but this can often be a warning sign; a failing share price means the company may struggle to remain profitable. This could mean it decides to cut back on dividends in the future.
- You must do sufficient research before buying any dividend share; investing without properly researching the company (and its profitability and dividend prospects) could mean you buy a poor-performing share which drops in price and doesn't pay a dividend at all. It's not uncommon for a good company to lose its market dominance, become loss-making and cease to pay dividends. If you buy into such a company, the share price will almost certainly fall, reducing the value of your original investment. You may have received a 5% dividend but you could, for example, lost 50% of your investment if the share price slumps. This article from Seeking Alpha explains the risks.
- Know This - New Zealand-only Shares: To compare 'apples with apples' when choosing a dividend share, you must look at the gross dividend. 'Earning per Share' (EPS) is not the same as gross dividend. To calculate the gross dividend, you must also include the tax the company has paid (imputation credit and/or withholding tax), and you will get a credit for those taxes.
- The NZX website gives the gross dividend yield - this is a good place to start your research, and you can see an example of dividends declared here for Spark.
- The complications around taxes are a further reason to conduct thorough research before investing in a dividend share. When comparing a dividend share with a term deposit, you need to look at the gross dividend yield, as this is the annual percentage return before tax. Your tax rate with decide what your net return is.
Our guide explains what you need to know about dividend shares to make an informed investing decision. We cover:
MoneyHub Founder Christopher Walsh shares his views on dividend shares:
|
"There are many 'growth' companies, but many don't grow and instead slow in revenue, go bust or get taken over for little money. Either way, the share price doesn't grow".
"Dividend shares are quiet achievers. In New Zealand, they tend to be established retailers, power generators, infrastructure owners and property investors. You may read 'best dividend' tables like this, but a super high percentage dividend doesn't necessarily mean you'll be paid out, as discussed below." "Before investing in any dividend share, ensure you know the company's history and have confidence it will likely pay out dividends. For example, a share price that drops from $2 to 75 cents in 6 months may show a high dividend on various financial websites, but it's likely to have seen falling revenue and/or profits. This means the company will likely cut the dividend and reinvest back into growth and development". "There are plenty of dividend-focused ETFs, as outlined in this list. While they're bought and sold in USD rather than NZD, the idea of these ETFs is to reinvest the dividends into new shares, so your investment keeps growing". "I like companies with a track record of profitability, dominance in their industry and a commitment to paying dividends yearly. They don't tend to disappoint and are much more reliable in creating long-term value. While you're unlikely to get the big upsides (for example, a share price going from $1 to $10), dividend shares are a popular element of any diversified investment portfolio". |
MoneyHub Founder
Christopher Walsh |
|
Your investor guide to Investing in Dividend Shares is sponsored by our friends at Kernel, a platform that offers a range of investment products (including a dedicated dividend fund) and innovative technology to grow your wealth with ease and all in one place.
|
What is a Dividend Share?
- A dividend share is a share that consistently provides a dividend back to its shareholders. This consistent payout contrasts with non-dividend paying shares, typically earlier in their lifecycle and focusing on revenue and industry growth rather than payouts.
- In addition, because dividends are paid out from a company's retained earnings or cash on the balance sheet, dividend shares tend to be older companies that have been able to generate profits consistently and have an established position in their industry. Examples of popular dividend shares include Coca-Cola, Johnson & Johnson and American Express.
- Dividends are used to entice investors to buy shares in the company. Companies that provide a steady income stream through dividends are popular investments for naturally more conservative people, such as retirees.
- Dividends are typically paid every three months, six months or (sometimes) annually to shareholders, partly as an enticement to hold their shares.
- The most attractive dividend shares will be those with the highest dividend yields (but not too high, as we'll detail the issues later on). A dividend yield is the amount of dividend the share pays out as a percentage of the current share price. For example, if a share paid out 10 cents a year in dividends and it's share price is $1 today, the dividend yield is 10%.
- The easiest way to find attractive dividend shares is by comparing companies' dividend yields in the same industry. If a company's dividend yield is much greater than companies in the same industry, it could be a sign of a good investment. At the very least, it's a sign to investigate into the company further and understand the quality of the business.
- Our video below explains our dividend shares guide in detail and why it's important to research every dividend share before investing:
Investing in Dividend Shares - Pros and Cons
Pros
Investing in dividend shares provides investors with many benefits:
1. Dividend Shares Can be Lower Risk than Other Types of Shares
2. Dividend Shares are More Stable (Less Volatile) than Growth Shares
3. Dividends Shares Can Provide A Reliable Income Stream
Cons
While dividend shares have a number of positive attributes, it’s important to recognize what the downsides of investing in dividend shares:
1. Dividend Shares Have Less Potential For Outsized Gains.
2. Disconnect Between Dividends & Growth of the Business
Know This: As seen in the above examples, a company has many different uses for profits instead of dividends, however companies with low dividends aren't necessarily bad businesses. And vice versa, companies with high dividends aren’t always good businesses and may be paying out shareholders instead of reinvesting into the company's future (which is an issue in the long term for shareholders). Further, companies are under no obligation to pay out shareholders in future years, so a company with a high dividend yield may stop paying dividends in the future, which can impact the return and share price investors expect.
3. High Dividend Yield Traps
Investing in dividend shares provides investors with many benefits:
1. Dividend Shares Can be Lower Risk than Other Types of Shares
- Dividend-paying companies tend to be stable and well-established. Because of this, dividend shares are unlikely to go out of business overnight (like some technology shares have in the past), given they've been around for so long.
- This longevity further supports the argument that dividend shares are often lower risk than other types (such as growth, micro-cap, technology etc.). This stability can be a positive for your portfolio as well-established large-cap companies are less likely to experience substantial losses and potentially go out of business.
2. Dividend Shares are More Stable (Less Volatile) than Growth Shares
- Dividend shares tend to exhibit slow, steady growth in their respective markets. Whether it's food and beverages, financial services or consumer retail, dividend shares tend to have extremely well-known brands, steady revenue and operate in a steady market. Compared to younger companies looking to disrupt an industry, dividend shares tend to have much less volatile share prices (apart from when the dividends are issued).
- Investors tend to speculate less on dividend shares than high-growth technology companies. Dividend shares tend to be household names that aren't associated with much excitement, so these shares are much less likely to experience excessive volatility (like the Gamestop saga that occured during COVID-19).
- Instead, investors that buy into dividend shares look for companies with dependable, safe cash flows with a strong track record of paying dividends. These investors typically hold investments for the long term rather than trade in and out of shares.
3. Dividends Shares Can Provide A Reliable Income Stream
- A dividend investor can use the stability and reliability of dividends to ensure that they get a healthy return in times of extreme volatility. The share market is quite volatile and will usually generate annual returns anywhere from +20% to -20% in any given year (but can be much more volatile in some years).
- This volatility can pose a challenge to retirees or investors looking for a steady source of income. Maybe these people have retired and use their investment returns to fund their lifestyles.
- During times of uncertainty and stress, when savings are low, and term deposits yield nearly nothing, a portfolio of high-yield dividend shares can be a lifesaver for retirees. For those not in retirement, dividend shares can provide much-needed income to supplement part-time/full-time work or contribute to a passive income strategy. Moreover, dividend shares continue to pay dividends, even in weaker macroeconomic conditions.
Cons
While dividend shares have a number of positive attributes, it’s important to recognize what the downsides of investing in dividend shares:
1. Dividend Shares Have Less Potential For Outsized Gains.
- One drawback to investing in shares for the dividend is that the growth in the share price of dividend shares is typically slower than high growth shares. In addition, because dividend shares pay out most of their profits as dividends, they retain less money to reinvest into the business. This lack of reinvestment can often mean their top line revenue growth increases slower than other high-growth shares.
- For example, companies like McDonald's, Exxon Mobil and Home Depot will grow their revenue slower than companies like Salesforce, Tesla and Alphabet. This slow growth is mainly because these high-growth companies are reinvesting their profits into the business and growing their top line revenue instead of paying out the profits to shareholders as dividends.
- Generally, this means that high-growth companies (particularly technology and software companies) can see their share prices jump around 20% or more per year. However, high dividend share companies may grow their share prices by 2-10% yearly. Most dividend investors make this trade-off when they purchase dividend shares. It's implicit that you will receive consistent dividends but have less potential for outsized gains.
2. Disconnect Between Dividends & Growth of the Business
- Another drawback of dividend investing is the risk of a disconnect between the growth of the company and the dividend yield/payout. It's important to note that when you purchase dividend shares, it's likely you're holding common shares. One of the characteristics of common shares is that companies are not required to pay dividends. A company can reduce or cut out its dividend payment entirely if it chooses to.
- Typically, dividend cuts happen when a business is struggling and can't pay the dividend with its generated historical profits. However, that isn't always the case. Sometimes a company will limit its dividend even if it makes a profit. CEOs can decide what to do with excess cash, and they don't always decide to pay out a dividend.
- For example, McDonald's may make $1 billion in profit this year, but they may decide to use that cash to open more franchises instead of paying it out to shareholders as a dividend. In this way, a company's strong growth does not mean it will maintain and increase its dividend yield. This uncertainty can be an issue for investors who purchase dividend shares, mainly for the company's historically high dividend returns.
- Additionally, a company might decide to reinvest its profits elsewhere instead of paying out a dividend to shareholders. There are several ways to put excess profits to use in a company aside from paying a dividend:
- Repurchase share, reducing the number of shares in circulation and increasing the percentage ownership of all the existing shareholders
- Acquire another business, either in a new industry or a competitor
- Pay back any debt the company has incurred
- Reinvest profits back into the business to hire staff, increase product development and build new product lines
Know This: As seen in the above examples, a company has many different uses for profits instead of dividends, however companies with low dividends aren't necessarily bad businesses. And vice versa, companies with high dividends aren’t always good businesses and may be paying out shareholders instead of reinvesting into the company's future (which is an issue in the long term for shareholders). Further, companies are under no obligation to pay out shareholders in future years, so a company with a high dividend yield may stop paying dividends in the future, which can impact the return and share price investors expect.
3. High Dividend Yield Traps
- You would think that the higher the dividend yield on a share, the more attractive that share is. However, be wary of companies that have extremely high dividend yields. While these companies may initially seem appealing, extremely high dividend yield shares typically have several risks associated with them (hence why they have such a high dividend yield).
- Ultra-high dividend yield shares may not be paying out such a high dividend yield by choice, nor does it guarantee that the dividend yield will continue to be that high in the future. These shares are known as dividend traps.
- For example, say a company's dividend is $1, and the share price is $50. The company has a dividend yield of 2% ($1 dividend / $50 share price). This payout would typically be considered a low dividend yield compared to other shares in the market. However, if the company's share price dropped 80% (down to $10) because of an unfavourable court ruling forcing the company to liquidate a substantial portion of its company, the dividend yield on the share would jump to 10%. Some investors looking at dividend yield alone may think this share is a good buy with a high dividend, but as detailed above, this is not always the case.
- High dividend shares can be a trap for investors just looking at dividend yield alone. It's important to research the whole company, including why the dividend is so high on the share. Is it because the company is in a good position and can afford to pay out a high dividend yield? Or has the share price dropped massively, leading to an artificially high dividend yield? Beware of high dividend yield shares.
|
Your investor guide to Investing in Dividend Shares is sponsored by our friends at Kernel, a platform that offers a range of investment products (including a dedicated dividend fund) and innovative technology to grow your wealth with ease and all in one place.
|
Top Five Dividend Shares - Global and New Zealand
Global Dividend Shares
Below is a list of the top high-dividend shares ranked by SimplyWallStreet's quality index. We have selected five from that list at random. Please note, the dividend yields were published in August 2022 - we have linked each share to Yahoo Finance so you can see the current/estimated dividend yield based on today's share price:
Generally, the example shares above are substantial in size (market capitalisation greater than $1 billion) and are well-known brand names and that operate in diverse, robust industries (such as diversified finance, utilities, pharmaceuticals and real estate). In addition, all five companies above have an estimated dividend yield of around 3%.
- Alexandria Real Estate ($25 billion market cap, 3% dividend yield)
- Bristol-Myers Squibb ($157 billion market cap, 2.90% dividend yield)
- Evercore ($4.4 billion market cap, 2.90% dividend yield)
- Exelon ($45 billion market cap, 2.90% dividend yield)
- Blackrock ($100 billion market cap, 2.90% dividend yield)
Generally, the example shares above are substantial in size (market capitalisation greater than $1 billion) and are well-known brand names and that operate in diverse, robust industries (such as diversified finance, utilities, pharmaceuticals and real estate). In addition, all five companies above have an estimated dividend yield of around 3%.
New Zealand Dividend Shares
Below is a list of high-dividend New Zealand shares, ranked by the most recent annual dividend yield on SimplyWallStreet. We have selected the five that stand out to us (but there are many on the list to consider):
The example list above are well-known brands and operate in diverse, robust industries (such as retail, food manufacturing and construction). In addition, all five companies above have an estimated high dividend yield (> 7%).
Know This: Before investing, we strongly suggest watching our dividend shares summary video here.
- Steel & Tube Holdings ($220 million market cap, 8.1% dividend yield)
- Warehouse Group ($1.2 billion market cap, 8% dividend yield)
- Fonterra Cooperative Group ($4.4 billion market cap, 7.3% dividend yield)
- Hallenstein Glasson Holding ($320 million market cap, 7.2% dividend yield)
- Fletcher Building ($4 billion market cap, 7% dividend yield)
The example list above are well-known brands and operate in diverse, robust industries (such as retail, food manufacturing and construction). In addition, all five companies above have an estimated high dividend yield (> 7%).
Know This: Before investing, we strongly suggest watching our dividend shares summary video here.
Frequently Asked Questions
What Shares are Better? Dividend or Growth Shares?
It depends. Both dividend shares and growth shares provide unique advantages and disadvantages to investors. Dividend shares can provide much-needed income through dividend payouts and are relatively stable/less volatile than growth shares but generally have limited upside from share price appreciation. While being much more volatile and potentially leading to larger losses, growth shares have a much higher growth profile and are much more likely to experience share price appreciation. The downside of growth shares is they typically don't pay out any profits as dividends.
A practical example of this is to compare Colgate to Facebook. One company has consistently generated profit and stable dividends for decades. In contrast, the other has seen its revenue explode while not paying any of these out as dividends.
A practical example of this is to compare Colgate to Facebook. One company has consistently generated profit and stable dividends for decades. In contrast, the other has seen its revenue explode while not paying any of these out as dividends.
Should I reinvest dividends or take the cash out?
The choice is up to you. Reinvesting dividends compounds your return, but many people like (and may rely on) the cash payments to help them with everyday expenses. What matters if you invest in the 'right' dividend shares by carefully researching profitable and robust companies.
How can I Find Dividend Shares?
Multiple free websites automatically pull data from financial statements to calculate the dividend yield on many different shares. These websites are the quickest and most effective:
|
Your investor guide to Investing in Dividend Shares is sponsored by our friends at Kernel, a platform that offers a range of investment products (including a dedicated dividend fund) and innovative technology to grow your wealth with ease and all in one place.
|
