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Jargon Buster: Dividends

Johannesburg - In a discussion with a would-be novice investor last night, it became apparent that many people aren't aware that as investor, they are entitled to a share of any profits a company makes.

In a number of the Fin24.com interviews and articles, readers will have noticed that many of the professional investment managers talk about the power and value of "dividends".

One of the leading South African fund managers we interviewed last week said that dividends in fact became the primary source of capital growth for investors over an extended period of time.

In a nutshell, a company goes about its business with the aim of making a profit.

The directors of the company then need to make a judgement call on whether there are sufficient cash resources available going forward.

If there is enough money in the business, then management may elect to declare a "dividend" either once or twice a year when the company reports its financial results.

The cash pile is divided amongst the shareholders according to the numbers of shares each shareholder holds.

These payments to shareholders are known as distributions or dividends.

From a tax and industry perspective, a company may elect to pay either a "dividend" or a "capital distribution". Unit, property and investment trusts typically pay distributions while industrial companies more often pay dividends:

With dividends, the company pays the tax obligation on behalf of the shareholder.

With distributions, the tax obligation is for the shareholders account and is viewed as income by tax authorities (i.e. will still need to be taxed)

Dividend yield

Often when reading a newspaper or visiting a financial news site, a reader will see the annotation DY or dividend yield.

This is the percentage of the current share price that the previous annual dividend made up. If, for instance, the share is priced at R10 and the dividend yield is 3% then the historical dividend paid is 30c for the previous financial year.

Special dividend

Occasionally a business will declare a "special" dividend.

Often what happens here is the business finds itself cash flush above and beyond the normal course of business. They may have sold a business unit and come into extra cash. They may elect to then return a portion of this to shareholders.

Passive income

Investment professionals point to the power of the passive income generated by dividends.

By investing in quality companies, a shareholder can develop a regular stream of income.

Many investment managers point to the extra cash flow that such dividends produce extra income that can be reinvested into additional shares, thereby compounding the growth of the income stream.

- Fin24.com

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