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What is Dividend and Dividend Yield? How is it important for the investor?
Dividends are the way by which a company returns back a part of its profits to shareholders. When a company earns a profit or surplus, that money can be put to two uses: it can either be re- invested in the business (called retained earnings) for future expansion projects or growth, or it can be paid to the shareholders as a dividend. Many companies retain a portion of their earnings and pay the remainder as a dividend. Dividends can be of three types.
- Interim dividend - usually paid quarterly
- Final Dividend - paid at the end of the financial year
- Special Dividend - paid under extraordinary circumstances when the company earns profit from an activity which is not in its scope of normal business. Say for example: An IT company earns profit from the sale of a land parcel.
Directors of a company have discretion as to how much of a dividend to declare or whether they should pay any dividend at all.
There are a few important terms that are important for an investor to know with respect to dividends.
- Dividend Declared = Face Value of the share X % Dividend Declared
- Dividend Yield = Annualized Dividend / Current Market Price
- Dividend Payout Ratio = Dividend Per Share (DPS) / Earnings Per Share (EPS)
DIVIDEND PER SHARE = Dividend Declared % x Face Value = 290 % x 10 = 29
DIVIDEND PAYOUT RATIO = Dividend Per Share / Earnings Per Share = 29/23.76 = 122.05 %
DIVIDEND YIELD = Dividend Per Share / Current Market Price = 29/347 = 8.35 %
Investors must note that dividend is denoted as a percentage of the face value of the stock and not the market price.
Dividend yield is a prominent tool used by investors to scan companies when there is a downturn in the stock markets as annual dividend payments act as a cushion against a free fall in the stock prices.
Historically, a high dividend yield has been desired by investors as the investors know what their minimum return on investment would be apart from any capital appreciation.
Click Here to view companies who constantly pay dividends or have a good dividend yield.
By the way, do you know that many investors focus on generating passive income by investing in only dividend-paying stocks? However, there are some key points to keep in mind while investing in stocks that have declared a dividend. Let us learn this in the next section.