Dividends… Explained!

Do you like my camera skills?  I love the iPhone- its so easy- take a picture and send it to myself in an email and….voila! A picture for my blog is ready!  Anyway, I digress, we’re talking about dividends here.

So what are dividends?

They’re something magical.  They’re great. Win-win in terms of taxation. They’re tax efficient.

Dividends, according to Investopedia are profits from the company and they can be either reinvested into the company or paid out in the form of dividends:

“Dividends may be in the form of cash, stock or property. Most secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend attempts to make up for this.”

I like the words “secure” and “stable”.  Usually only big time companies (corporations) offer dividends to their stockholders.  High growth companies reinvest their earnings into the company to make the company grow bigger and faster.  High growth companies’ share prices may move more.

Canadian Corporations Dividend Tax Credit

Canadian corporations that pay out dividends get a tax break, so you get one too.  In fact, the dividend income (which you have to report or else the tax man will be after you) that you get is tax efficient.  Dividend income from Canadian corporations are taxed at a lower rate than other forms of income.

You get a dividend tax credit (you’ll see the dividends paid out on your T5 slips) which you submit during tax season.  The formula is pretty complicated, but it pretty much sums up to you paying very little in dividend taxes.  The dividend tax credit came about because the Canadian government doesn’t want to tax you twice (it taxed the corporation already so it won’t tax you as much).

Canadian Dream Free at 45 explains the Canadian Dividend Tax Credit in Depth on his blog.

Also, sometimes you get a negative tax amount with Canadian dividends, and this can be used to reduce the taxes payable. Taxtips.ca explains in depth.

However, the Canadian government doesn’t get a hoot If you bought a foreign (e.g. US) corporation’s stock and it paid out dividends.  These dividends would be considered foreign and you won’t get a tax break.  They don’t care about taxing you twice.  You’ll pay tax on that dividend like you pay tax on a GIC (interest income) or other non-tax efficient sources of income.  Before you know it, that chunk of money will be whittled away to something much smaller.

So what do you need to look for in a dividend paying stock?

You want to look at the Dividend Yield.  Let’s take FTS.TO for example (it’s a gas and electricity utility company) .  It’s current dividend yield is 3.46. So if you were to buy it at its current price of $32.33, the percentage back you would get in dividends is 3.46%.  The current dividend is $0.28 quarterly.  Multiple that by four, you get $1.12.  $1.12/$32.33= 3.46%.

You can see that the dividends paid out for the past year is $1.10 ($0.28 Aug, May, Feb and $0.26 last November).

That’s another good sign.  When they have CONSISTENTLY increased their dividends over a long period of time, you know the corporation you’re investing in a stable company and your investment shouldn’t (but you never know, I suppose) hurt your portfolio.

FTS.TO went from $0.16 a share in 2006 to $0.28 a share!  That’s a 75% increase in dividends in less than five years.

Likewise goes for a company who suddenly decreases their dividends.  You know you’re in hot water if a company decreases their dividends (namely MFC.TO which I also own).  Investors will start jumping ship.

Readers, this is a very basic explanation of dividends, is there anything else I might be missing that you want to add? What portion of your portfolio do you include Canadian dividend paying corporations?

About

Young is a writer and former owner of Young and Thrifty and the main "twitter' behind Young and Thrifty's twitter account. She lives in Vancouver, BC and enjoys long walks on the beach, spending time with her anxious dog, and finding good deals. If you like what you read, consider signing up for email updates.

24 Responses to Dividends… Explained!

  1. Good post :)

    Yes, owning all companies that consistently increase dividends is great, but they are a rare breed. If you hold stocks long enough, some simply can’t keep up. MFC increased for many years, and then ran into a small wall. I’m afraid the same will happen to Sun Life at some point. (I own that, not MFC). Oh well, I figure as long as I’m getting paid, that’s the main thing. Dividends never lie :)

    • @Financial Cents- I think Sun Life is different though, because Sun Life doesn’t have exposure in the market as much (or at all, i think) like MFC. I like how you said “Dividends Never Lie” that could be like a new personal finance movie title lol! Very catchy :)

  2. I like the favorable tax treatment with dividends in comparison to say interest income derived from GICs, etc.

    Great job highlighting Fortis as an example. I bought FTS for my TFSA last year and it’s a great example of a large-cap company that just pays a consistent dividend. I almost forget to check on my position.

    I think you’re not giving yourself enough credit regarding the article being very basic, because a lot of people I meet don’t realize that the tax impact of buying U.S. dividend paying stocks results in the dividends being treated as interest income.

    Of course, that is the downside of investing in U.S. equities. The upside however, is hard to ignore. Given the value of the Cdn dollar and the fact that it allows the investor to gain exposure to sectors normally not available in Canada (such as JNJ, PG, CL, KO, etc.) while further diversifying with foreign plays, makes them hard to resist IMO. I have yet to dive in with some U.S. equity purchases, but I’m hoping to in the very near future.

    Awesome post.

    • @The Rat- So happy to see you hear Rat! Hope to see you around more :) FTS has really sky rocketed eh? perhaps everyone else found out how great FTS is… That’s true re: US equities. Some of them have great consistent dividends and are great companies. I think it would be good to have US equities a registered account to avoid the taxes. Guess it depends on the amount of dividend payments too in US equities. :)

  3. “FTS.TO went from $0.16 a share in 2006 to $0.28 a share! That’s a 175% increase in dividends in less than five years.”

    Don’t think you know how to use a calculator… That’s a 75% increase not 175%.

    • @TorontoSteve- Oops thanks for noticing the typo. Oftentimes I am writing these posts late into the night so my brain doesn’t work properly sometimes. My bad! Thanks Steve.

    • @Pat- Hello Pat :) You work with Mike at The Financial Blogger too right? I think I would tell new investors to hold on to the dividend paying equity- the market fluctuates momentarily all the time, and some people like to take advantage of buying before the dividend payout and cashing out after… these are just momentary dips of the mood of mr. market.

    • It is important that people understand the difference between the income and capital value of a dividend producing stock (or fund).

      Think of it like a house that you own that pays you rent. The price of the house doesn’t really matter, as long as you don’t need to sell it right now, so long as you keep getting your rent payments, it’s all good.

  4. I love dividend stocks! Invest in companies that have consistently raised dividends and have scope for growth. Companies with very high dividends can spell trouble (always check the company’s debt and cash flow).

    Sad that Canada’s going to tax Canroys. But it was good while it lasted!

  5. Interesting Topic. “Canadian Corporations Dividend Tax Credit”. This idea might have a good and bad impact to others.

  6. @Jean Bullington,
    “This idea might have a good and bad impact to others.”

    I agree on you but on my own opinion, let our Leaders decide and investigate about this issue. ^_^

  7. @Robin: I agree with you man because I really don’t have any idea about dividends but this article gives me a lot of information.

  8. i get the dividend income tax benefit, but you are still paying taxes. why not just buy dividend stocks through your tfsa? am i missing something?

    • You absolutely could if you have room in your TFSA PJ. Also, of note, if you make a low enough salary you can actually make money on the way dividend income is treated with taxes, depending on a few variables.

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