Companies pay dividends to their shareholders from their profits after corporate taxes have been paid. They do not want to totally deplete their cash reserves, so they make sure they have ample liquidity available for working capital in order to keep the company running on a day-to-day basis.

Most investors purchase shares in a company hoping that the share price will rise at some point in the future. Investors who purchase shares in a company that pays dividends will also collect an income (usually paid quarterly) while they wait for the share price to rise.

In Canada, investors who earn dividends receive a preferential income tax treatment compared to paying a full tax rate on regular income or interest income. This tax break was designed to avoid double taxation, as the
corporation has already paid income tax on its earnings and the investor should not have to again pay tax on the same corporate earnings. In Ontario, an investor who pays income tax at the top marginal tax rate, would have to earn 6.35% in interest income to equal 5.00% in dividend income before taxes.

A lot of large companies do not pay dividends, as they want to fund their own growth as a business entity. They feel that their shareholders will benefit more from the increase in value of a larger, more profitable company in the future, rather than receiving a quarterly dividend cheque. Growth stocks have not fared well during the recent extended stock market decline.

On the other hand, they tend to perform better in rising markets. Dividend-paying stocks are usually less volatile in their price movements.

Investors typically find the best dividend yields with utilities, banks and other financial services companies. Currently yields range from 3% to over 5%.

When selecting a stock, its dividend-payment history should be noted. How long has the company been paying a dividend? Has the company increased its dividend over the years? How does its dividend yield compare to other companies in the same industry?

Canadian banks offer a good source of comparison. Currently the 5 biggest banks in Canada have a dividend yield range from 2.71% to 3.83%. Higher
yields usually represent the banks that have had poorer results in the recent past.

The most attractive feature for investors is that in down markets, as well as in up markets, there is a dividend stream being collected, while the investor waits for the anticipated price appreciation of the stock. Unlike
bonds, there are no guarantees of dividend payments. A company has to declare a dividend payment. Also, unlike bonds, dividend payments can increase over time, giving a greater return to the investor.

E-Mail:rein.lee@researchcapital.com
Telephone: 416-860-7758

Archived Articles

TRENDING