Chapter 4. What’s in it for Me?

You’ve invested your money and naturally want something in return. There are three ways you can benefit from a stock market investment:

1. dividends

2. capital gains

3. shareholder perks.

Dividends

Most companies pay dividends, which come out of their profits. This is similar to receiving interest from a savings account in a bank. You get a flow of income without touching the capital invested.

If you want to invest for income – say you are retired and want to put your nest egg where it will provide you with a regular supply of cash to live on – then you will look for companies paying a dividend that is increased year by year. This is known as a progressive dividend.

Dividends are paid out of what are called distributable reserves. In simple terms, this is the pot of cash that has been built up out of the profits remaining after all the bills have been paid, including tax and previous dividends.

The cash that is not distributed to shareholders in the form of a dividend is used to pay off debt, meet day-to-day bills or to fund expansion.

Dividend cover

Companies generally aim to cover the dividend twice. That means that in any year they hope to earn twice as much as they pay out in the dividend.

For example, supposing a company makes £100m in profits after tax. Let us also suppose that it has 200m shares in issue, so it has earned 50p for each share (called earnings per share). Say it pays a dividend of 20p a share. That means the dividend is covered 2.5 times by earnings – in other words earnings are two and a half times the dividend.

These figures are purely a simple illustration. In real life they hardly ever come out in round numbers, as we can see in the following table of actual examples. However, company results always include a figure for earnings per share and one for the dividend, so you can easily see whether the dividend is covered.

Table 3: Sample earnings per share and dividend figures

Company	Earnings after tax	No of shares	Earnings per share	Dividend total	Cover
Dixons Carphone	£389m	1,152m	33.8p	11.25p	3.00
DFS Furniture	£39.5m	211.5m	18.7p	11.2p	1.67
MJ Gleeson	£26.2m	54.1m	48.5p	24.0p	2.02
JD Wetherspoon	£56.1m	111.3m	50.4p	12.0p	4.20

Source: Company results announcements in 2017

We can see that dividend cover can vary considerably. This may be because of a blip in earnings or the result of a deliberate policy by the company concerned.

In the table above, housebuilder and urban renovation specialist MJ Gleeson is very close to the accepted norm of covering dividends twice. At the time of distributing this dividend, like other housebuilders, Gleeson has recovered well from the financial crash and can feel confident that the run of improving profits over recent years will continue.

It is generating cash, plans to build more homes and has completed building on some less profitable sites – so the future is promising and Gleeson has increased the dividend in line with rising profits.

Pubs group JD Wetherspoon has by far the most cautious level of dividend cover, twice the norm. This is sensible, as companies selling directly to consumers can be subject to sharp swings in spending. Take-home pay has been squeezed during the years of austerity and fluctuations in the weather can considerably affect beer sales. Input costs continue to rise and the rise in the minimum wage continually pushes up staff wages.

In addition, Wetherspoon has an expansion programme, so cash is needed to fund new pub openings and refurbishments.

Wetherspoon will be able to maintain the dividend even if the going gets tougher because the high cover level leaves plenty of leeway.

Telecoms retailer Dixons Carphone also takes a cautious attitude. It, too, depends on continued consumer spending, and that spending can surge or shrink according to whether a new generation of mobile phones is on its way.

The big worry in our table is DFS Furniture, where cover has fallen well below two times. DFS suffered a sharp turndown in sales in the second half of its financial year to the end of July 2017, leading to a fall of 22% in its full-year profits. It has, however, maintained the dividend at the previous year’s level.

To make matters worse, in addition to the regular dividend total shown in the table, DFS declared a one-off special dividend of 9.5p earlier in its financial year when sales were going rather better. Adding together the interim, final and special dividends gives a total of 20.7p, which is not fully covered by earnings of 18.7p.

When the dividend is not fully covered, a company has to raid reserves built up in fat years as it trades through thin ones. This cannot be done forever, because the reserves will dwindle and when they run out it will not be legally possible to pay out any more.

If a company chooses to maintain its dividend – to pay the same amount this year as it paid last year – even though the dividend is not fully covered, it is hoping to do better in future and to restore profits to a comfortable level.

With the furniture market showing no signs of improving, there was a serious possibility that in the following year DFS would have to reduce its dividend.

Dividends paid in instalments

Most companies in the UK pay dividends twice a year:

· once after the half-year end (the interim dividend)

· once after the financial year end (the final dividend).

Add the two together and you have the total dividend for the year.

As a rough guide, about one third of the total is usually paid out at the halfway stage and two thirds after the year end. There is no set formula for this division and you should not be suspicious if a company pays the two dividends in different proportions.

Reasons for a smaller interim dividend

There are two main reasons why the interim dividend tends to be significantly less than the final.

Firstly, the company does not have a full picture of how well the year is going at the halfway stage. After all, it has only half the year’s figures to go on. This is particularly true of companies that depend heavily on Christmas trading – in most cases the festive season falls in the second half of the financial year.

It also applies to holiday companies that run at a loss during the quieter winter period and make all their money in the summer sunshine. They tend to have a financial year end in September, so the first half may give only a preliminary indication of how the full year will pan out. Who knows in March how many last-minute bargain hunters will leap off their sofas to snap up cheap breaks?

A company’s financial year is determined by the company. Most choose 31 December or 31 March but other factors can come into play. For example, retailers tend to have a financial year end around 31 January during the lull after Christmas trading. Travel companies use 30 September as the year end when the summer season has finished and the winter season has not yet begun.

Some companies, mostly retailers, have a 52-week financial year rather than a calendar year, which is 52 weeks plus one or two days. This is to avoid the distortion caused by having an extra Saturday, the heaviest day of the week for turnover, fall into a financial year. Unfortunately this does mean that every five or six years there has to be a 53-week year to soak up the extra days, which arguably causes a far greater distortion.

There is no cause for shareholders to be concerned about when the year end is, or whether it is a calendar year or 52 weeks, as long as the company produces accounts consistently every 12 months.

The second reason for the smaller interim is more technical. Strictly speaking, the directors merely recommend the dividends: the payouts have to be approved by the shareholders at the annual general meeting.

You and your fellow shareholders are hardly likely to demand a smaller payout. So the directors pay the interim dividend reasonably safe in the knowledge that it will in the fullness of time be approved by the shareholders. There are no qualms about the final dividend because the annual meeting is called after the full-year results are announced and the final dividend is not paid until that meeting gives the go ahead.

Just for the record, turkeys do on rare occasions vote for Christmas. There have been instances of a major shareholder arguing that it is in everyone’s interest to preserve cash to develop the business for a long-term and, ultimately, larger gain rather than pay out a smaller amount now.

Paying more or fewer dividends

A few companies pay quarterly dividends. This happens more in the US than the UK but larger companies with an international standing – such as oil giants BP and Shell – pay out quarterly to keep their American investors happy. The three interim payments tend to be equal instalments and the final dividend may be larger – but again there is no set formula for how the total is divided.

Some smaller companies pay only one, final dividend. It is obviously twice as expensive to post out cheques two times a year rather than just once. It may be inconvenient to wait a whole 12 months for your dividend but there is no reason to suspect the soundness of such a company. Rather, it can be a cause for rejoicing that a company with limited resources uses them prudently.

Finally, we have companies that pay no dividend at all. These are obviously of no use to you if you are looking for a stream of income from your shares unless, perhaps, there are genuine reasons to believe that a dividend is imminent.

It is possible that the directors have decided to preserve cash to use in expanding the business. More likely is that the company is loss-making or has no distributable reserves so it is in no position to pay a dividend.

Dividend size

Whether payments are half-yearly or quarterly, the policy on how much to pay out at each stage remains much the same year by year at each individual company. So if the interim dividend is unchanged, it is unlikely that the final will be increased either.

On the other hand, if the interim is raised, then the company is clearly confident that the year is going well and the directors are expecting – barring any nasty surprises – to raise the final. So if the interim is raised, say, 5% you can hope that the final dividend will also go up 5%. This is not guaranteed, and indeed if everything goes swimmingly you might get even more, but if trading tails off in the second half you could be in for a disappointment.

Companies do occasionally rebalance the respective proportions of their dividends. For example, directors who have been extremely cautious in setting the interim dividend in the past may feel able, after a few years of strong trading, to increase the interim faster than the final dividend over one or more years, so as to bring the ratio into line with the norm.

When a company decides to rebalance the dividend it will say so in its results statement, usually before such a change is made, or possibly to explain a large dividend increase that has just been recommended.

Successful companies will have a progressive dividend policy – that is, the dividend will be raised every year. This is great for investors because the rising payout will offset the effects of inflation.

Not so good is when companies ‘rebase’ their dividends. This is a euphemism for saying that the company is not making sufficient profits to justify the dividend at its current level. By setting a lower dividend for the latest financial year, the company hopes to be able to start a progressive dividend policy but from a lower level.

All companies quoted on the London Stock Exchange give a five-year summary of key financial figures in their annual report, usually near the end. The following table shows a selection of dividends paid by four companies.

Table 4: Sample dividends paid over five years

Company	Business	2013	2014	2015	2016	2017
Utd Utilities	Water	34.32p	36.04p	37.70p	38.45p	38.87p
Barratt Developments	Housebuilding	2.5p	10.3p	15.1p	18.3p	24.4p
Morrisons	Supermarket	11.8p	13.00p	13.65p	5.0p	5.43p
Marks & Spencer	Retailing	17.0p	17.0p	18.0p	18.7p	18.7p

Source: Company annual reports

United Utilities provides the pattern of steadily rising dividends that long-term investors are looking for. There is just one area of possible concern: the increase has been getting smaller each year.

Barratt Developments, in contrast, has seen its dividend leap from a very low base. The reason is that it scrapped the dividend in the wake of the credit crunch in 2008, which saw housebuilders plunge into losses. So when the dividend was eventually restored, Barratt started cautiously before getting back to normal as quickly as possible. Investors may hope the dividend will continue to rise but should not necessarily expect such great increases in the future.

Morrisons was doing fine until it got caught up in the supermarket price wars sparked by budget chains Lidl and Aldi. As profits were squeezed, Morrisons decided to pump more cash into the stores and hand less to shareholders. There is early evidence that the progressive dividend policy has been resumed, though at a much lower level.

Marks & Spencer has a rather stuttering record, having raised the dividend twice and left it unchanged twice.

Dividend currency

The dividend will be declared in pence per share, in euros per share if the company is based in the Republic of Ireland, or in US cents in the case of some international companies, particularly those in the oil industry. Very rarely, some other foreign currency may be used, such as the Australian dollar.

If a foreign currency is used, the dividend will be converted into sterling at the prevailing exchange rate before it is paid to you.

Special dividend

Occasionally a company will pay a special dividend. This is usually much bigger than the interim or final. It happens when a company suddenly finds itself with more cash than it can use and the directors decide to return it to shareholders rather than leave it to gather dust in a bank account.

One instance is when a company sells a major business to another company for cash. Another possibility is that the company has been very successful and has built up a cash pile over the years. Eventually the directors realise that they do not need to set so much aside for a rainy day.

A special dividend will usually be in addition to the interim and final dividends. This is so that the special dividend is clearly seen as a one-off. You cannot expect another special dividend the following year.

Payment dates

When a dividend is announced, the company will set two dates:

1. Qualifying date. Shareholders on the share register on this date are entitled to receive the dividend.

2. Payment date. This is the date on which payment is transferred to your bank account through the BACS system or the dividend cheque is sent out.

There is no set time frame for dividend payments. Some companies pay within a few weeks of declaring the dividend; others wait months.

Up to the qualifying date, the shares will be bought and sold cum dividend. That means with the dividend. If you sell shares at this stage, the right to receive the dividend passes to the buyer.

Ultimately the day arrives when the company decrees that all shareholders on the register at that point will receive the dividend. This is always at the close of stock market trading on a Friday, which makes sense as there is a natural dividing line between one week’s trading and the next.

Or it would make sense, except that even in this age of instant electronic trading it takes two days to update the share registers. Thus the shares go ex dividend – that is, they are bought and sold without the dividend, immediately trading starts on the Thursday. From this point you keep the dividend if you sell the shares and you are not entitled to it if you buy the shares.

When shares go ex dividend, the price will normally fall to reflect the fact that the buyer will not get the payout. You would expect this fall to be roughly equivalent to the size of the dividend.

Let us take five companies that went ex dividend on Thursday, 19 October 2017. Shares generally fell on that day, with smaller companies losing more ground than larger ones.

The following table shows the size of the dividend paid and the movement in each company’s share price that day.

Table 5: Effect of going ex dividend

Company	Dividend	Share price change	Effective change
Howden Joinery	3.6p	-10.6p	-7.0p
BAE Systems	8.8p	-15.5p	-6.7p
John Menzies	6.0p	-5.0p	+1.0p
Ted Baker	16.6p	+20.0p	+36.6p
Marshalls	3.4p	+21.2p	+24.6p

We can see that Howden Joinery and BAE Systems fell more heavily than the value of the dividend, reflecting the weak market that day.

Distribution and aviation services group John Menzies saw its shares slip, but not by quite as much as the dividend. In effect, the shares ended the day fractionally higher than you would have expected.

Clothing retailer Ted Baker defied gravity with a substantial gain despite there being no news from the company that day to underpin the shares.

Shares in Marshalls, which makes paving stones and other gardening items, performed spectacularly well, although the trading update it issued that day simply said there had been no change in profit expectations since its half-year results were released two months previously. Markets had been nervous that Marshalls could have seen sales suffer from the squeeze on consumer spending and the patchy weather that summer, so in this case no news really was good news.

Note: The dates of dividend payments can usually be found in the ‘investor relations’ section of companies’ websites. Companies also include the ex-dividend date and the payment date when they announce their results.

Capital gains

You may be more interested in seeing the value of your shares rise than in receiving a steady stream of income. In that case you will be looking for companies that you feel are undervalued by other investors and whose share prices will rise as other investors catch on. You want to get in first.

The money you invest is referred to as capital and any increase in its value is a capital gain.

Having it both ways

You can have the best of both worlds by investing in companies that see their share prices rise as the dividend goes up. In fact, you may ask, surely the two go together?

An ideal investment could be thought of as one where the profits rise year by year, and the dividend paid out of those profits similarly rises – making the shares more attractive, so that more investors want to buy and the share price goes up further.

Quite right. Profits, dividends and share prices often do move in the same direction in roughly equal measure.

Do remember, though, that the stock market rarely moves in symmetrical ways. Some companies may pay out more in dividends while others retain the cash for expansion. A company that has made heavy losses in the past may seem a worthwhile investment now it is making profits – but it may have no reserves left to pay a dividend.

Shareholder perks

A minority of companies offer shareholders discounts off their products or services. These include jewellery, clothing, food and drink, air fares, new and used cars and magazines.

For example, Eurotunnel offered its original shareholders three free trips through the Chunnel each year, while various housebuilders have offered thousands of pounds off one of their new homes.

These perks can look very attractive but there are several disadvantages:

1. Most obviously, if you do not want to travel by car to France or buy a new home from a particular builder, the concession is of no use to you. There is no point in buying shares at Moss Bros if you get your suits at Marks & Spencer.

2. A minimum shareholding is often required to qualify for the perk. Although in some companies just one share is sufficient, others reserve the benefit to holders of at least 2,500 shares.

3. Companies may require investors to hold the shares for a minimum period, usually one year but sometimes longer.

4. Perks can be withdrawn or changed, so it is difficult to keep track of what is currently available. Some companies notify the shareholders about what perks are offered in the annual report, so you have to buy the shares first and find out your entitlement later.

When you are paid cash as a dividend you can spend the money as you please. But with perks you are stuck with what you are given.

The following table shows a selection of the perks that have been, and may still be, available – but investors will need to check with individual companies to ensure that the concessions still exist. The number of companies offering perks has tended to dwindle over the years.

Table 6: Sample companies and perks offered to shareholders

Company	Sector	Perk	Minimum shareholding
Adnams Leisure	Leisure	15% discount on food and accommodation	1 share
Inchcape	Retailing	15% discount on servicing, £100 off car price	100 shares
Safestore	Property	25% discount off storage costs	100 shares
Telecom Plus	Telecoms	10% discount	1,500 shares

The most comprehensive list of company perks is collated by the stockbroker Hargreaves Lansdown and is available free on its website at: www.h-l.co.uk/free-guides/shareholder-perks