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James Cooper is a senior equities analyst with Morningstar.

Compared to shares bank deposits offer relative safety, but the value of the deposit - the capital - does not grow. This means income increases only with rising interest rates and will decline should rates fall.

Because of this lack of growth, bank deposits typically offer a higher nominal yield than the dividend yield on shares. When making the comparison, investors need to add the impact of franking, or the credit the investor receives from the Australian Taxation Office (ATO) for the tax already paid by the company on profits before paying dividends. Interest income includes no such benefit.

Dividends franked to 100 per cent are grossed up by 100/(1-tax rate) or 100/70 or 1.43 to calculate the pre-tax profit that constituted the dividend. To calculate the after-tax return, the investor applies their personal tax rate to the grossed up amount and deducts the (usually) 30 per cent tax already paid by the company.

A 5 per cent yield when grossed up by 1.43 is 7.15 per cent or the same as a 7.15 per cent bank deposit rate. A well-chosen share will have a dividend that consistently grows above the rate of inflation, over time trouncing the rate of growth in bank interest, which can be negative.

Assuming constant sharemarket valuation multiples, the rising dividend will result in a higher share price, unlike a bank deposit which doesn't grow in value. But the share price can fall even if the dividend continues to grow. This could be a function of general price declines across the sharemarket, across the relevant sector, or specific factors that change the outlook for the company.

That said, shares with strong, resilient yields tend to fall less than the overall market due to the immediacy of their tangible dividend returns. Put another way, investors pay less for future growth potential when their confidence in the economy/sharemarket deteriorates.

Dividends grant the investor the freedom to direct the free cash flow generated by the company as he wishes - reinvest it into the same stock, in a different stock, or spend the money. Investing in a company that retains the majority of earnings requires confidence management won't waste the capital. If growth plans go awry, then lower-than-expected dividends - or none at all - might be the outcome, and hoped for capital gains may instead be losses.

A culture of paying reliable and growing dividends imposes a discipline on management that discourages careless or speculative deployment of capital. When investors are accustomed to reliable dividends, they will not look kindly on management that fails them in this regard.

It is important dividends are not paid when the company needs the cash to sustain its business. Investors need to understand a company's capital requirements, which may be irregular but significant.

The payout ratio, or dividend per share (DPS) divided by earnings per share (EPS), provides some sense of the safety of the dividend. Investors should also examine how sensitive earnings are to changes in revenue. If fixed costs and interest expense are a relatively meaningful proportion of gross profit, then earnings could contract very quickly if conditions deteriorate, leaving little for dividends.

A company's weakening share price due to a deteriorating outlook boosts the prospective dividend yield if analysts are slow to reduce dividend forecasts. Investors should therefore be skeptical about unusually high dividend yields.