Disclaimer
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
In our new jargon-busting series, we’ve covered the basics of investment trusts, gearing and why trusts trade at a discount or premium. This week we’re running the rule over dividend yields and how income can enhance returns for investors.
Let’s get the obvious question out of the way first: what is a dividend? Well, it’s a payment made by companies to their shareholders as a way of distributing the company’s profits. Payments are often made twice a year but can also be made monthly, quarterly or annually.
Investment trusts owning a portfolio of companies may receive a series of dividends over the course of a year and, as a result, the board will decide the level of the trust’s own dividend. The investment trust will normally have a dividend policy that provides general guidance about the dividend that investors can expect over the medium to long-term. Each year the board will make an assessment of the actual dividend it will pay, taking into account its overall policy and the level of dividends received from portfolio companies in the current year.
We’ll cover the different sources of dividend payments (and the ‘AIC dividend heroes’) in a future jargon buster but the board of directors of the trust will look to balance the needs of income-seeking investors against re-investing surplus funds to drive future capital growth for investors.
Moving onto the dividend yield, this is simply calculated as the current (or forecast) dividend per share divided by the current share price of the trust. For example, if a trust has paid an interim dividend of 4 pence per share and a final dividend of 6 pence per share, and the share price is currently £2.00, the current dividend yield would be 5% (10 pence divided by 200 pence).
The dividend yield indicates the level of income you might receive from an investment and may often be used as a proxy for the interest rate on savings accounts. While dividends are not guaranteed, the investment trust structure provides some unique attributes to support dividends, which we’ll cover in a later jargon buster.
The average dividend yield for the AIC investment trust universe is currently just over 3%, however this ranges from 0% to 46%. Care should be taken over very high dividend yields which can indicate a steep drop in the trust’s share price due to financial difficulties (and the dividend is likely to be cut or scrapped in the future).
Looking by sector, dividend yields are often 8-10% for debt-related trusts where income is the main source of returns and negligible for technology-focused trusts where the potential growth in net asset value is the primary driver of returns.
As a result, investors should factor in the income-based returns from dividends, as well as potential capital growth, when making investment decisions.
If there’s anything you’d like us to cover in future jargon busters, drop us an email at [email protected] or [email protected].
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