The directors were conscious that larger companies usually try to cover the dividend two or at most three times with earnings but Winnstay made it clear from the start that it would probably be targeting a higher dividend cover policy. The board felt a cover of about four times was appropriate.
Paul says this openness has been well received by the stock market – indeed some shareholders indicated that they would be willing to forego dividends in the early years to allow more cash to be invested in the company.
However, Wynnstay has stuck to its intention of increasing the dividend by 5-10% each year since it changed its financial year from the calendar year to the 12 months to 31 October in 2006.
Table 1.3 – Historic dividend payments by Wynnstay
Paul says:
The dividend virtually sets itself. If we were unable to extend the dividend by the expected amount we would probably find it necessary to give an explanation to the market.
He says that the board effectively only has to decide the odd decimal point in the dividend level and “there is rarely a big discussion”. As finance director he has an understanding of what the market is expecting and proposes what the dividend should be, possibly after chatting to senior colleagues, before presenting the results to his fellow directors.
Different types of dividends
Besides straightforward cash dividends (which is the main topic of this book), there are some other types of dividends – which are briefly described below.
Scrip dividends
Many companies offer you the opportunity to take your dividend in the form of more shares in the company rather than cash. This is known as a ‘scrip dividend’. The company will say in its results announcement whether it offers a scrip dividend.
Not all companies offer this option and it may not be available to you if you run an online account where shares are held in a nominee account. Check with your broker whether you will be able to elect to receive scrip dividends.
Basic rate income tax will still be deducted from the dividend before the number of scrip shares due to you is calculated according to the level of the cash dividend and the stock market value of the shares. New shares will be issued accordingly.
If, as is likely, the amount of the dividend is not divisible exactly by the share price and there is a fraction of a share left over, the difference is – depending on the particular terms of the scheme – paid to the shareholder, added to the next dividend, retained by the company, or given to charity.
If scrip dividends are issued to a company in your ISA account, the new shares qualify for tax relief under the ISA scheme.
Scrip dividends are attractive if:
You want to build up your investments.
You have a range of investments and are not looking to diversify into more companies.
The company is doing very well and you are happy to keep on investing in it.
You do not consider the shares to be overpriced.
Scrip dividends are not attractive if:
You want income to live on now.
You want to widen your portfolio.
Your portfolio is already weighted too heavily in shares in this particular company or the sector it operates in.
You feel that there are more attractive prospects elsewhere.
Dividend reinvestment plans
If a company you invest in does not offer scrip dividends, it may still be possible to take dividends in shares through a dividend reinvestment plan, known as a DRIP – an appropriate acronym not because dividend reinvestment plans are stupid, but because they allow you to drip more shares into your investment pot.
The difference between a scrip issue and a DRIP is that no new shares are issued with a DRIP. Instead, participants in the scheme have their cash dividend paid directly to the scheme administrator, which is usually the company’s registrar. The administrator then calculates the number of shares to which each participant is entitled and buys the shares on the stock market. Shares are then distributed to the participants.
The administrator will obtain the best price it can for the purchase and because the share purchases can be aggregated, the dealing costs tend to be relatively low.
The arguments for and against DRIPs are exactly the same as for scrip dividends. If you elect to take scrip dividends where possible you will almost certainly be keen to take advantage of DRIPs as well. DRIP shares issued into an ISA account remain within the ISA wrapper just as scrip dividends do.
A list of companies that have a DRIP scheme can be found on the Equiniti share registrars website at:
www.shareview.co.uk/Products/Pages/applyforadrip.aspx
Where companies offer neither a scrip dividend nor a DRIP, your stock broker may offer a dividend reinvestment scheme, automatically reinvesting the cash dividend into the relevant company’s shares. Again, the arguments for and against are the same as for scrip dividends and again any shares issued in this way remain part of an ISA.
Some brokers lump together dividends paid to several clients holding shares in the same company and buy new shares immediately. Others wait until cash builds up in each individual client’s account before buying. Aggregating cash in this way reduces dealing costs.
When you set up an online account you will be asked whether you want to have dividends remitted to your bank account or retained within the investment account. If you want your dividends to be reinvested automatically, check that this option is available, otherwise find another online broker.
If you are operating a traditional account with your broker, ask if this option is available.
Special dividends
Occasionally companies will pay a special dividend. This is a one-off payment in addition to the normal interim and final dividends but, unlike the regular payouts, it will not be repeated the following year.
A special dividend usually arises when a company has sold some assets for cash and has no obvious way of using that money to expand the business. Another possibility is that the company has retained large sums of cash from previous profits, possibly to finance a planned acquisition that never materialised, and has finally decided that there is no point in hanging on to the money.
One should not look a gift horse in the mouth and it is right that this money should be handed out to shareholders who do, after all, own the company and all its assets including cash.
A special dividend does imply that the company is on a sound financial footing and that regular dividends are secure for the foreseeable future, otherwise the company would shore up the balance sheet or keep the cash in reserve to maintain regular dividends.
On the other hand, if the company has sold assets its earnings may be reduced in future. Another negative view could be that if the company is returning cash to its shareholders then this suggests the directors are lacking in ideas of how to grow the company. You need to look at the circumstances and decide.
Whatever the reason for the special dividend, remember that it is a one-off