Profits and returns can change quickly
How to Calculate the Dividend Yield
The formula to find the dividend yield is simple: divide the annual dividend payments by the stock price.
For example: Suppose you buy a stock at $10 per share. The stock pays dividends of $0.10 each quarter, which means for every share you own, you’ll receive $0.40 annually. Using the formula above, divide $0.40 by $10, which gives you 0.04. Then, convert 0.04 to a percentage by moving the decimal point two places to the right. The result is 4%, meaning this stock has a dividend yield of 4%.
Companies that Pay Dividends
Dividends are the way profits return directly to shareholders. There’s no specific rule about which companies will pay dividends and which won’t. Even if a company has paid dividends in the past, it may stop at any time.
Large companies with stable profit growth are more likely to issue dividends. However, fast-growing startups are less likely to do so. This is because new companies need to gather all the money they can to finance their growth. This is true for startups, which may not have yet achieved profitability. When buying stocks in these companies, you are hoping for an increase in stock price rather than receiving steady income from dividends.
Stock Prices Reacting to Profit Changes
During a recession or other difficult times, the value of dividend-paying stocks can drop quickly because there’s a risk that the company will reduce future payouts. If a company announces that it will cut dividends, the stock price will react immediately.
When the market improves, the stock price may rise again, as investors hope the company will increase dividends once more. However, if the economy deteriorates, the stock price could drop further. This is due to investors’ concern that the company will stop paying dividends.
Looking Beyond the Dividend Yield
Unless a dividend cut is announced, the yield is calculated using the most recent payments. You should also consider other factors before making a decision. Some details to look for include the payout ratio, dividend history, and performance.
Retrieving the previous example where the stock price was $10. Suppose a recession hits and the stock price drops from $10 to $5. But the company did not announce any change in the dividend payout. So, if you just found the stock, you would use the previous payments to calculate the yield. You would divide $0.40 (annual dividend payments) by $5 (new stock price) to get 0.08, or a yield of 8%.
If you only look at the dividend yield, this stock might seem like a great buy. However, it’s wise to note that the stock price has dropped, which is why the yield is high. You might also expect the company to cut dividends in the future. In this case, you wouldn’t use the dividend yield as the sole reason to buy the stock.
Dividend Funds
If you do not want to study and buy individual stocks, you can invest in a dividend income fund instead. These funds allow you to diversify your portfolio while letting experts make the tough decisions about which stocks to buy and when to buy them.
There is a trade-off, however, as you have to pay fund managers who make these decisions on your behalf. To find out how much the fund charges, look for the expense ratio, which will tell you how much of the fund’s assets are pulled to cover costs each year.
Yield
Profits vs. Bond Yields
Bond yields are calculated in the same way that dividend yields are calculated. However, it’s important to remember that stocks and bonds are not the same.
The company is required to pay a specified amount of interest to those who hold the bonds it issues. On the other hand, the company is not obligated to pay dividends to its shareholders. This means that during uncertain times, you can rely more on the stable investment income from bonds than on the dividends paid by stocks.
Frequently Asked Questions (FAQs)
Why do companies pay dividends?
Companies pay dividends as a way to attract investors by sharing profits with them. This may not be a viable strategy for small companies that do not yet have sufficient profits to share, but for established companies, it is a way to attract investors looking for income.
How are dividends paid?
Companies typically pay cash dividends directly to the investor’s brokerage account. If the company pays dividends in stock, those shares will appear as additional shares in the investor’s account.
What is a good dividend yield?
Generally, a dividend yield of 2% to 4% is considered strong, and anything above 4% could be a great buy but is also risky. When comparing stocks, it’s essential to look at more than just the dividend yield. Always evaluate the yield alongside other important stock features such as stock price, earnings per share, price-to-earnings ratio, and more.
The Balance does not provide tax, investment, or financial services advice. The information is presented without regard to the investment objectives or risk tolerance or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of loss of principal.
Source: https://www.thebalancemoney.com/understanding-the-dividend-yield-on-a-stock-2388525
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