15. Apr 2019 Equities

Dividends – bread and butter income from equities

Equity investors benefit from price gains and dividends. But prices can, of course, go down as well as up. Dividends offer steadier participation in entrepreneurial success.

  • Two sources of return on equity investments: price gains and dividends
  • Dividends are an important component of the return on equity investments
  • Investors participate directly in company profits through dividends
4 min. to read

$1.37 trillion:

Global dividends climbed to this record level in 2018 - an increase of 9.3 percent over the previous year.

There are two ways in which investors can earn a return on equities: through price gains and dividend income. You don’t always get both. Stock prices fluctuate almost always, and sometimes by the second. This volatility that we take for granted on the stock exchange is actually paradoxical. After all, shares are ultimately shares in a company - and as a rule a company is not worth more or less from one moment to the next.

The connection seems still more tenuous when a stock rises significantly for no apparent reason over a longer period of time and then - out of the blue, so to speak - falls back to the level from which the upward rally started. What's going on? It’s clear that the stock market is strongly influenced by emotions in the short term: rumours about new orders, company acquisitions, changes to the industry’s outlook or corporate leadership.

Stock market prices are influenced by emotions

The markets react immediately to this news with joy, fear, euphoria or panic. On the spur of the moment the market makes its decision - and these rapid decisions are flawed, which is why the stock market keeps adjusting. Only in the longer term does a fair value settle in.

Equity investors are thus exposed to the whims of the stock market in the short term. This is also the reason why they should invest long term, so that pricing reflects future prospects and profit developments and value is not distorted by the market’s irrational exaggerations.

Nine out of ten companies worldwide raised their dividends in 2018 or kept them stable

Constant dividends

While the price of a share moves up and down every day, dividends are much more constant. German stock corporations usually pay dividends to their shareholders only once a year. The Board of Management of a stock corporation proposes a dividend at the Annual General Meeting (AGM). The shareholder meeting then decides on the amount of the dividend, based on development of the business in the past year.

If business went well, the dividend will be more generous.  If parts of a company have been sold, there may even be a special dividend. So-called dividend continuity – the practice of continuing to pay a reasonable dividend – is very important to most companies.

Solid dividend policy

A solid company pays attention not to distribute too much nor too little in order to retain sufficient reserves for investments and be able to pay a dividend again in the next financial year. The dividend should increase from year to year if possible, should not be cancelled and should yield a decent return in relation to the share price.

For the plan to work, a company must have a good industry position and competent management. Investment in a company like this offers the investor participation in its success, at first with no influence from what happens on the stock exchange. Dividends are therefore the calmer side of share investment.

47.5 billion dollars:

German companies paid this much in dividends in 2018 - an increase of 25 percent over the previous year. An absolute record: no other country in the world paid out more dividends in 2018.

Dividends as an entrepreneurial component

Dividends also make the entrepreneurial component of a share clear. The share buyer participates directly in the company's profit distributions. The price of the company’s shares do not necessarily do so because share prices are influenced by market turbulence.

The dividend’s relationship to the share price - the so-called dividend yield - is quite significant. According to the Handelsblatt newspaper, the 160 companies of the DAX, MDAX and SDAX indices are expected to pay out a record 52.4 billion euros in dividends in 2019(1). The average dividend yield in the DAX should be 3.7 percent, in the MDAX 3.0 percent, and 2.2 percent in the SDAX[1]. There is no guarantee that this will be the case. But in view of the low interest rate environment and the current weakness of stock markets, these returns look quite ample.

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1. Handelsblatt Online, "Distributions: 52.4 billion euros - Shareholders can expect record dividends", January 30, 2019

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