Tuesday, October 9, 2007

Why A Dividend Payment Is Important To An Investor

To an investor looking for high and fast capital gains, a company that makes a dividend payment is a low priority. However, for long term investors, research shows that such a payment is an important part of the overall return on investment.

Many of the biggest quoted companies have been paying an annual dividend every year for years. Part of the appeal of their shares as an investment, and part of the valuation in the price is this dividend policy and reliability.

As a general rule, the largest companies also make the largest and most secure dividend payment. Of course, this can never be true of every situation, but the bigger and more established businesses have the security and often the profits to cover a payment comfortably.

It may not be the most rewarding of actions for a company which has a track record of creating a high return on investment to pay funds out to shareholders. Unfortunately, there are too few businesses of this nature. Company management also recognize that by paying an annual dividend their company can potentially be called an income stock.

Income stocks are not necessarily viewed as 'sexy' in the market, but there is a wide array of mutual type funds that specifically invest in such companies. This of course opens the way to much larger institutional investment in a firm which in turn will help to underpin the price in the market. As big funds buy big holdings, the number of shares floating in the market will usually be reduced. By lowering liquidity, the share price will generally be assisted.

There are, of course, many investors that will purchase company stock and are specifically attracted by the payment of a dividend. These investors will use the payment to subsidize their income and as such, value stability.

It is for this reason that once company management has started paying an annual dividend, they will be fearful of ceasing payment. Should the income funds be forced to sell their holdings, the market price will almost certainly suffer. The bonuses and stock options of management are usually tied to this market price!

A private investor will almost certainly be required to pay income tax on any or all dividend income received. In many countries, some of this tax is deducted at source so that the dividend payment is reduced and the company sends money to the tax authorities on behalf of investors.

Stuart Langridge is an experienced investor, investment adviser and writer. For more information about the workings of the stock exchange, please visit: