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Equities Example
Which of the following investments gives, to a person liable only to 30% basic tax, the better flat yield, ignoring all brokerage and other charges?
(a) 5% funding stock at a price of 70;
(b) £1 shares priced at 210 paying a net cash dividend of 13p.
Answer:
(a) £70 invested will yield £5 gross, which works out at 7.143% gross;
(b) £2 . 10 invested yields 13p net. Thus £210 invested would yield £13
net which works out at 6.19%. Since this is a net after 30% tax figure one must divide by 7 and multiply by 10 to give 8.84% gross.
Therefore (b) is better. Prices and yields
It will now be realised that declared rate of dividend and actual rate of yield on the money invested are very different measurements. A published figure of 4p net per share as dividend on a £1 share (or 4% net on the nominal stock) is quite meaningless for estimating the income to be generated from a purchase, because the price at which the share or stock stands in the market may be very different from the nominal value; it may be higher, it may be lower. If the £1 shares are worth only 33p the 4p (or 4%) net dividend would be the net income on a capital outlay of 33p, equivalent to a net return of 12 .12% . To express it as a yield this figure would need to be grossed up for tax. Assuming a basic rate of 30% tax, a figure of 12.12% net represents a gross yield of 17.3%.
Assessing ordinary shares
Deciding whether to buy or sell the shares of any particular company or shares in any particular sector of the economy is really an exercise in forecasting what is going to happen in the future to that company or in that industry. Will it expand or contract? Will the company be well managed, enjoying the benefits of new inventions, or will it suffer from technical obsolescence of plant?
Professional investors and others with specialist knowledge have the time and ability to make careful analyses of the conditions in which whole industries and companies within them operate. The amateur investor can only seek advice and supplement that advice by the application of a few elementary tests based on the figures in the company's published accounts.
Tax On Dividends
Dividends received by a shareholder have already borne corporation tax. To avoid tax being paid twice on the same income, the dividend is treated by the Inland Revenue as though it has paid basic-rate income tax in the hands of the shareholder. For most shareholders, therefore, a dividend is 'tax paid' and no more tax will be payable on it.
On the advice form or 'tax voucher' that the shareholder receives with his dividend warrant there will be a note of how much 'tax credit' is associated with the dividend payment. This tax credit is normally the amount which must be added to the net dividend... see: Tax On Dividends