HEY guys. This week I continue the series on de-mystifying some of the terms around investing and making it less scary (and less boring). Our topic today is “dividends”. Just like “stocks” last week, this is another term that everybody and them cousin “know”, but not everybody actually knows. I touched on it a little last week but this week it’s best to give it more depth.

So, just in case you always wondered, or already knew but wanted a refresher, here’s my simplified definition and explanation of what dividends are. Let’s start with a simple one-liner explanation.

WHAT’S A DIVIDEND?

A dividend is a direct payment of a company’s profits to its shareholders.

Boom. That’s the simple version, but now you know.

So, what’s the more complex version? Well, it doesn’t really get too complex, but there are some rules around dividends. Now, to understand the deeper rules, there is one more thing you have to know. In a company, all the profits that aren’t used up (or paid out as dividends each year) get recorded in the company’s books as something called “retained earnings”. Retained earnings are literally what the name says; profits that are kept in storage, also known as, retained profits. They are sometimes called “accumulated profits” or “accumulated earnings” but they are all the same thing; they show how much of previously earned profits a company has kept.

Now, since dividends are a payment out of company profits, that means the company has to make a profit in the past in order to pay out a dividend.

What does this all mean? Simply, if a company’s retained earnings are negative (less than zero), then the company cannot pay a dividend.

This happens when a company’s losses in the past are more than any profit the company has made. For any amateur investors seeking to invest for dividends and want to know if a company is generally capable of paying one, they can check the retained earnings line in that company’s financial statements.

All financial statements for all companies listed on the Jamaica Stock Exchange (JSE)are available from the JSE’s website www.jamstockex.com. Anyone can go there and see how any publicly listed company is doing. Check it out.

HOW ARE DIVIDENDS PAID?

Dividends are paid out to all shareholders in equal amounts based on the number of shares each person has. Now some dividends may be paid out to preference shareholders, instead of common shareholders; once a dividend is to be paid out to any class of shares (common, preference or golden/special share) the entire class of those shares has to be paid equally.

That means that if company XYZ has 100,000 regular shares, and wants to pay a dividend of $1,000,000, it has to pay out $10 per share ($1,000,000÷100,000 regular shares).

This is designed to keep things fair for all shareholders, big or small. I touched on this last week and the same rule applies; if you want more of a company’s dividends, you have to own more of a company’s stock.

Investors often measure dividend payments against the share price to see how much value they are getting. This is called dividend yield (Dividend ÷ Share Price).

Using our previous example, assuming that Company XYZ’s share price is $100 the dividend yield would be 10 per cent ($10 dividend ÷ $100 share price = 10% yield). This would be considered a large yield in Jamaica since most annual dividend yields for JSE listed companies are much smaller.

The average yield for JSE Main Market companies for the year so far is roughly 1.3 per cent. A 10 per cent dividend yield would make investors buy company XYZ’s shares in a rush!

Dividends are usually paid by sending each shareholder a cheque in their name. Many investors often find themselves with multiple dividend cheques which pile up because, who really wants to go to the bank?

Many brokers offer something called a “dividend mandate” however, which is a document that you sign instructing dividends to be paid directly into an account of your choosing. This saves you the trouble of waiting on a cheque in the mail and having to visit a bank to deposit or cash it in.

Ask your broker if they have a dividend mandate and save yourself from standing in a bank line today! Dividend mandate’s often come with a small one-time fee, and can be anywhere from $200-$1500+ depending on your broker.

Next week in part two of dividends, I will explain when dividends are paid, among other issues.

Randy T Rowe is a business strategy consultant and autodidactic investor…Which is a fancy way to say he was too poor to lose any money so had to teach himself to invest carefully & sensibly. You can find him on Twitter (@RTRowe ) and on his Personal Finance website www.everymickle.com. He sometimes wonders if fa’asing in people’s business pays heavy dividends…It would explain why so many people do it…hmm…