Why share prices aren’t always the full story

When people think about investing in a company’s shares, they often focus on whether share prices rise or fall. But share price movements are only part of the picture. Another important way investors can potentially benefit is through the regular payments some companies make to their shareholders, known as dividends.

Not all companies pay dividends. Many fast growing businesses – particularly in areas like technology – prefer to reinvest most or all of their profits back into the business to fund expansion, develop new products or acquire other companies. More established firms, which may have steadier cash flows and fewer major growth projects, are often more likely to share some of their profits with shareholders.

When you buy shares, you are becoming a part owner of the company. Dividends are a way for companies to share a portion of the profits they make with those owners. However, it’s important to understand that dividends are not guaranteed. Even companies that have paid dividends for many years can choose to reduce or stop payments if profits fall, costs rise, or business conditions become more challenging.

Nevertheless, dividends can play an important role in the overall return you get from investing. Your total return from shares comes from two sources:

• changes in the share price, and
• any dividends you receive while you hold the investment.

This can be particularly valuable when share prices are volatile, moving sideways, or falling. In those periods, dividends can still provide some return, helping to smooth the overall investment experience. In practice, UK companies usually pay dividends twice a year, while many US companies pay them quarterly. For investors who want regular payments, dividends can provide a relatively steady flow of income.

The UK market tends to see high dividends relative to a market like the US. However, in the US, share buybacks are used more often. Share buybacks are when a company uses spare cash to buy some of its own shares.
Dividends often attract the most attention during tougher economic periods, when markets are unsettled or when interest rates are low and other sources of income are less attractive. But over the long term they can be an important building block of returns from a diversified portfolio - one that spreads investments across different assets such as shares and bonds.

How reinvesting income can help investments grow

You may have heard of compounding, often described as a ‘snowball’ effect. This is when returns start to build on top of each other over time. Dividends can contribute to compounding if you reinvest them instead of taking the cash.

For example, imagine you own shares in a company and receive a £10 payment. If you use that £10 to buy more shares, you then own slightly more of the company than before. The next time a payment is made, it’s likely to be based on your larger holding, so you could receive a little more. Over many years, repeatedly reinvesting income in this way can significantly increase the value of your investment.

This approach means your investment isn’t relying solely on share prices rising. Instead, growth can also come from gradually increasing the number of shares you own. While reinvestment doesn’t remove risk - companies can still cut or stop dividend payments, and share prices can fall - it can materially improve long-term outcomes.

Dividends often attract the most attention during tougher economic periods, when markets are unsettled or when interest rates are low and other sources of income are less attractive. But over the long term they can be an important building block of returns from a diversified portfolio - one that spreads investments across different assets such as shares and bonds.

By contributing both during market ups and downs, dividends can help create more balanced and resilient outcomes for investors. Please note dividends are taxed differently from share price gains. If you're unsure, it might be worth speaking to a financial adviser. Please note that they typically charge for this service.
 

Key things to remember

• Some companies share their profits, which can add to returns over time.
• Reinvesting can help build momentum, especially when investing for the longer term.
• Different companies have different priorities, offering a mix of growth and income opportunities.
• Spreading investments helps create balance and can smooth the journey over time.
• Staying invested over the long term gives compounding more time to work.