Shares and non-speculative investment
A share is a credit instrument that represents a property share of the capital of a joint-stock company or a partnership limited by shares.
While the trader profits on the difference between the purchase price and the sale price of a financial instrument, the non-speculative investor who buys shares in order to build a financial income for oneself hopes that in the long term the company will produce a satisfactory flow of profits (earnings), and above all to be able to periodically cash-out his portions of distributable earnings (s.c. dividends).
The purchase and possession of shares are by nature risky activities, because a priori we cannot know with certainty (but only estimate) neither the trend over time of the share price (quotation), nor (above all) if the company will produce satisfactory earnings, nor to what extent will distributable earnings be effectively distributed to shareholders.
When we acquire ownership of shares, we take on the role of company shareholders (partners), therefore we suffer both the business risk related to the corporate activity and the market risk due to share price changes over time.
For these reasons, before considering the purchase of shares of a specific company (and of course during the ownership period of the shares) the investor should carefully evaluate all the available accounting documents (balance sheets, income statements, notes to the financial statements, etc.) together with all the information available on the corporate activity and on the related real economy market, as well as the information related to the listing financial market.
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Shares as a means of protecting capital
In order to build a financial income for ourselves, first of all it is important to protect one’s own capital (as the experience of the best investors teaches).
The investor’s capital is really safeguarded only if:
1. we choose limited financial liability investments (the eventual bad performance of which, in other words, does not harm the investor’s entire net worth but is limited to the capital invested in the single project)
2. in the event of an investment in a company, if it is subject to an adequate level of obligations and controls
So if we choose to invest money in a company in order to create a financial income for ourselves, the most logical thing to do is to buy shares of a limited company (but not to become managing partner of a S.a.p.a., because he has unlimited liability for social debts).
The shares of listed companies, compared to the shares of unlisted companies
The shares of joint-stock companies listed on regulated markets (ie. on the Stock Exchange) are the most sensible and protected (although risky) type of corporate investment, and the one on which as shareholders we should focus our utmost attention. In fact, listed companies are much more supervised by the competent authorities, because these companies must comply with a greater number of obligations and requirements than unlisted companies.
Once rigorous controls have been passed, a joint-stock company that meets the numerous necessary requirements can be listed on the Stock Exchange with an IPO (initial public offering) on the primary market, selling (through a bank that manages the documentation and the procedure) its first shares to the first underwriters, from whom it will thus receive money as risk capital to finance its business.
Subsequent purchases and sales of shares already sold on the primary market will take place on the secondary market between buyers and sellers. The share prices will be calculated – and will vary – following the law of supply and demand.
The shares of listed companies can be purchased and sold instantly on regulated markets (telematic by now), save for any exceptional and temporary limitations deliberated by the competent Supervisory Authority (CONSOB for Italy) in case of necessity. The purchase and the sale take place through a qualified financial intermediary, i.e. through the bank or SIM (securities brokerage company) where the customer has his securities account.
On the other hand, the shares of unlisted companies are traded on unregulated markets, and therefore for negotiation we have to turn to financial intermediaries who act as market makers by preventively gathering purchase and sale proposals for such shares. In other words, for the shares of unlisted companies, neither the purchase nor the sale at the desired conditions of price, quantity and time are guaranteed.
Dividends: formation and distribution
At the end of an administrative period (usually coinciding with the calendar year), the economic result of the management can be: a loss, a balanced budget or (as is hoped) a balance-sheet profit (earnings).
Not all eventual earnings realized by a company are distributable. Dividends are the portion of earnings distributed by a company to its shareholders as remuneration for their invested capital.
Only the portion of truly realized earnings remaining after the allocations to reserves required by law – and if provided, by the company statute or otherwise approved by the shareholders’ meeting – can be distributed to shareholders.
Directors have the formal power to decide whether, when, how much and how to distribute dividends to shareholders, based on the company’s possibilities and necessities. In fact, the ordinary shareholders’ meeting may or may not ratify their dividend choices when approving the financial statements.
The shareholders’ meeting may deliberate the distribution of two types of dividends. The s.c. normal dividend is distributed with periodic regularity, whereas a s.c. extraordinary dividend may sometimes be distributed, without any regularity, on particular occasions.
Furthermore, in Italy any interim dividends can be distributed only by companies obliged to undergo auditing and only if the strict legal requirements are met.
Dividend distribution policies
Each company can choose whether or not to distribute dividends to shareholders.
There are four main types of dividend policy that a company can follow, should they want to distribute dividends to their shareholders.
The “stable dividend policy” aims to regularly distribute dividends in each period (regardless of the performance of the business), which tend to fluctuate between a minimum and a maximum value. To stabilize the outflow of dividends, it is necessary to set aside part of the earnings to reserve during the positive years, so that normal dividends can be distributed also during negative years.
This policy is followed by many large companies and favors the shareholder as much as possible, who by seeing the stability of his own dividends will have an incentive to remain a shareholder of the company.
The “residual dividend policy” means that the company distributes any excess earnings to shareholders in full when it realizes them. However, this policy can leave the shareholder without dividends in periods when there are negative economic results (losses).
The “percentage dividend policy” is more prudent than the previous one, and distributes as dividends only a percentage of the distributable earnings of the period, leaving the rest of the resources available to the needs of the company.
The “progressive dividend policy” aims to distribute a dividend that gradually grows over time, calculated on the basis of long-term earnings estimates.
Forms of dividend
Dividends are very often distributed in the form of cash (cash dividend), that is, by crediting money to the accounts held by shareholders with their authorized intermediaries (banks and securities brokerage companies).
However, sometimes a dividend distribution in the form of shares (stock dividend) can be deliberated, that is, with a free share capital increase through the issue of new shares, to be assigned to individual shareholders free of charge and in proportion to the number of shares they already own (for example, 1 new share every 10 old shares owned).
The payment of dividends by a company
In companies that distribute dividends, these can be paid to shareholders on a periodic basis: annually (so in many Italian companies), or half-yearly, or quarterly (so in many American companies) or in some cases even monthly.
Companies pay dividends to shareholders not on the dividend maturity date, known as the “detachment” date (ex [dividend] date), but on the date chosen for the distribution of dividends (pay date, which usually falls within three working days following the “detachment” date for Italian shares and may be later on in the case of foreign shares).
The calendar of dividend “detachment” dates and dividend payment dates of companies listed on Piazza Affari is published in the appropriate section of the official Internet website of the Italian stock exchange. In many cases, the dates can also be known by visiting the websites of the companies in question and specialized financial websites.
The cash-out of dividends by the shareholder
To cash-out share dividends, the shareholder must own the shares of the company until the opening of the stock exchange session of the day on which the right to dividends for the period accrues (dividend “detachment” date or ex date). Only after this opening will the shareholder be able to sell his shares without losing the right to cash-out dividends, while the buyer will accrue the right to cash-out dividends only on the next “detachment” date.
The dividends due to the individual shareholder are obtained by multiplying the DPS (dividend per share), ie. the dividend due to the single share, by the number of shares held in the portfolio on the dividend “detachment” date.
If distributed in cash, dividends – net of withholding tax, where applicable – are credited to the shareholder, proportionally to the number of shares held at the time of the dividend “detachment” day, to his account by his intermediary bank or securities brokerage company.
We advise you to consult the dividend calendar of the Borsa Italiana website here.
Relations between share price and dividend
The value of a share on the market (quotation) is said to be “with accrual” (tel quel price), because the price includes the dividend accrued up to now. For the price, the approaching of the dividend maturity date (ex date) is fundamental, while the dividend distribution date (pay date) does not affect the price. A real “dividend effect” is therefore created on the value of the share, which we explain as follows.
In summary, as it’s logical, the price of a share tends to rise gradually as the dividend “detachment” date approaches. Immediately after the “detachment” of the dividend, the price of a share drops approximately by the amount equal to the dividend accrued, reaching the price defined ex dividend (without dividend or dry price).
In substance, since the share price is affected by the proximity of the dividend “detachment” date (tending to increase as the ex date approaches), there is basically no convenience for the buyer to buy a share a few days before the “detachment” only to cash-out the dividend.
However, those who buy the shares on the “detachment” day will enjoy a lower purchase price – the “ex dividend” quotation – and therefore may be able to purchase a greater number of shares, in addition to the fact that in doing so in fact, the private shareholder can postpone the moment in which he will have to be taxed until the payment date of the subsequent dividend.
Taxation of dividends
The taxation of dividends in Italy takes place according to the cash principle, that is, at the time of the actual cash-out of dividend by the shareholder (therefore neither on the day of their accrual, nor on the day on which the distribution was deliberated). Currently, the situation is as follows.
Share dividends paid by a company resident in Italy or non-resident but with a permanent establishment in Italy are taxable in Italy.
Share dividends paid by a company not resident in Italy are also taxable in Italy, if the recipient is resident in Italy or the permanent establishment of a non-resident company.
The type of taxation suffered by dividends in Italy will depend on the type of recipient subject.
For private individuals (natural persons not entrepreneurs), the dividend is considered to be capital income and a 26% tax is applied, calculated on 100% of the tax base for Italian shares or on the s.c. “net frontier” amount for foreign shares that have already suffered a withholding tax abroad. If the tax is withheld and paid for the private individual by a company resident in Italy, then the private individual will receive the net amount on his account and will not be obliged to insert these income in the tax return (730 or Unico).
If the shareholder is a sole proprietorship or a partnership, on the other hand, the dividend is considered business income therefore natural persons operating in this form will not be subject to withholding tax but to be taxed according to the normal personal income tax rates, calculated however on 58.14% of the normal tax base.
Dividends received by a capital company are also considered business income. The company will not be subject to a withholding tax, but will be subject to an IRES tax, which however (if the company does not reside in a black list country) will be calculated on only 5% of the normal tax base (and therefore 95% of the tax base will be exempted from taxation, in fact causing the application of an effective tax rate of 1.2% (0.24 x 0.05) on the amount of dividends: an extremely favorable tax regime!)
In the case of double taxation (foreign and Italian), to remedy it, where applicable, it is necessary to apply the competent Convention against double taxation between the two countries between which the movement of money with which dividends are paid occurs, or in any case the provisions of the rules of the two countries must be applied. Where the conditions exist, the exemption method can be applied to avoid double taxation.
The dividend yield
The dividend yield is a percentage rate definable as the ratio obtained by dividing the aforementioned DPS (dividend per share), or unitary dividend (ie. due to the single share) at the end of the period, and the price of the share itself at the end of the period.
It can be calculated with precision only when we know the exact amount of the dividend, conversely we will have to make an estimate based on an assumed dividend.
A share has a variable yield precisely because with the same dividend, because of the aforementioned dividend effect, the effective yield rate tends to rise as the share price drops, and to decrease as the price increases.
At this point, it seems logical to consider the problems that arise in comparing the dividend yields of the various companies, problems due to the fact that not all companies distribute dividends with the same periodicity and regularity.
To determine whether the dividend yields of two companies that pay with different periodicity are equivalent (e.g. whether the annual dividend of share A is equivalent to the half-yearly dividend of share B), it is necessary to calculate the annual yield rate where necessary.
According to financial mathematics, two rates (e.g. annual rate A and half-yearly rate B) are equivalent if for the same capital C and time T they produce the same sum M of principal and interest. Therefore, otherwise the dividend yield of a company will be higher of the dividend yield of the other company.
Dividends from a non-speculative investment perspective
For the non-speculative investor, with the same risk, it is rational to try to own shares of listed companies that regularly provide dividends with the highest possible yield rate. This type of investor therefore should not own shares of companies known to not distribute dividends.
On this issue, it is worth remembering that in growing economic sectors, and obviously during crisis periods (such as the COVID-19 period), to avoid resorting to more expensive forms of financing, many companies may decide to reduce the distribution of dividends to shareholders or even to not distribute them. By contrast, the probability of dividend distribution increases in mature economic sectors and during favorable economic periods.
For the optimal construction and management of our stock portfolio, it is therefore important not only to be well aware of the performance of the economic activities carried out by the companies of which we are or could become shareholders, but also of the aforementioned corporate policies on the topic of dividend distribution.
And where the yield of the shares of the national market does not satisfy us, it is necessary to broaden our horizons and to keep an eye on foreign markets to see the shareholding opportunities present there.
Building a financial income for ourselves through shares is not really an easy thing, as we have to study many notions and many documents, and we must always keep up to date on the performance of the activities of the investee companies and on the reference financial markets.
Moreover, to receive noteworthy financial income it is necessary to invest considerable capital, which one must be willing to risk. To reduce overall risk, investments need to be diversified in the right way.
Those who are capitalized, patient and skilled in their job as informed shareholders will certainly reap interesting results in the long term.
Conversely, those who think that investing in shares is too complicated, could always profit from the price fluctuations of the shares as a trader, perhaps considering (after an adequate period of theoretical study) the opening of a trading account with a serious broker, for example at XM which offers CFD contracts on stocks and stock indexes (as well as on many other financial instruments).