For many investors working with stocks, the ultimate goal is to make a profit. If you have bought a stock or more, you have two ways to do it:
- Sell the asset when it grows in price.
- Get dividends paid.
While point one seems simple — buy cheaper and sell at a higher price — point two requires more attention.
What are the dividends?
Note that paying dividends is not obligatory for companies: first and foremost, it is their right. Roughly speaking, if a company decides against paying dividends to its shareholders, no force will make it do so. In such a case (if the company generates a net profit), it may spend its funds on development and modernization. Each shareholder has the right for dividends; their size depends on the company. In essence, dividends are the shareholder's passive income. Each company pays as much as it can, depending on the profit it makes. The size of dividends may either increase or decrease with each payment.
The dividend yield reflects the investor's income from the securities they own during the whole period of holding them. As a rule, it is more profitable to buy stocks of several companies (create a portfolio) to diversify market risks.
Not always does the chosen company make a profit during the accounting period. In case the company has made no profit, it may refuse to pay dividends.
How to calculate the dividend yield?
The dividend yield is presented in percent of the stock price and the dividends on it during a certain period. If we compare normal and privileged stocks, we will notice some differences in calculating and paying dividends. Privileged stocks provide their owner with a fixed amount of dividends in the accounting period.
Normally, dividends are paid to the holders of privileged stocks, and then to ordinary shareholders; this is the advantage but also a small drawback — a privileged shareholder has no voice in making decisions on the company's future. So, the investor has to choose the category of the stocks they buy.
Holding ordinary stocks, an investor has a voice, the weight of which directly depends on the number of stocks the investor owns: the more of them they hold, the more important their voice is. An ordinary shareholder gets a share of the company's profit in the form of non-fixed payments.
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Calculation of dividends
The company sets the sums and condition of dividend payments based on their dividend policy and writes it down in its financial documentation that you can find on the company’s website. The size of the payments is not directly bound to a certain sum: the company can equally pay dividends from the net profit or free money flow.
When to expect your dividends?
If the company registers a profit after the publication of its quarterly report, it appoints a board of directors that decides upon the calculation of dividends (the decision is based on the dividend policy of the company). Then the complete suggestion is discussed by the board of shareholders where the final size of dividends is set. The size can be corrected according to the situation in the market, country, or due to some force majeure events.
What is a dividend yield?
The dividend yield reflects the profit that the investor will make over the investments they have made. Also, it reflects the general state of affairs in the company and its investment appeal. The higher the dividend yield, the more attractive is the company. A profitable company attracts more investments, allowing it to develop quicker and, hence, remain attractive.
The yield is calculated using the formula:
Dividend yield = (Yearly dividend / Stock price) * 100
Normally, the size of the yearly dividend is taken from the previous year, but if the accounting period is a quarter, the size of quarterly payments is just multiplied by 4. As long as the stock price changes constantly depending on the market situation, in certain cases, the average stock price is taken. Thus we get an average dividend yield.
Example of dividend yield calculation
Let us take an imaginary company and round digits for easier calculations. Company A put 1,000 stocks in the market for 20 USD each. The dividends paid last year amounted to 5 USD per stock. By the formula, we get a dividend yield of 25% per annum.
Company B put 1,000 stocks in the market for 100 USD each. Let us imagine the dividends at the same level of 5 USD per stock.
As we can see, the two companies pay the same sum per stock but the percentage varies significantly. In such a case, investors will most probably choose the company with a higher dividend yield. Estimating how many stocks you can buy for a certain sum, you can forecast the final result of your investments.
How to calculate the final result of your investments?
Let us discuss another simple example. An investor has 1,000 USD. They decide to invest in Companies A and B described above. These are the digits we get:
- Option 1: for a 1,000 USD, they can buy 50 stocks of Company A (if they cost 20 USD each). The dividend yield is 25% per annum, which makes 250 USD.
- Option 2: for 1,000 USD, they can buy 10 stocks of Company B (if they cost 100 USD each). The dividend yield is 5% per annum, which makes 5 USD per stock, or 50 USD of profit totally.
As we can see, the first company is more attractive for investments, and the investor will get more profit per invested dollar. However, other factors are also to be taken into account. Particularly, remember that we use the results of the last year, and there is no guarantee that in the future we will make the same or a larger profit. Here, we have calculated the performance of imaginary companies; in reality, the digits are much smaller, somewhere between 5-7%.
To start investing for dividend yield, you need to study the market and find the most promising sectors of business and companies. If in the last accounting period one sector of economy used to grow, this time the biggest profit can be generated in another one.
Also, note that a low stock price does not always mean a low dividend yield. For example, stocks that cost 20 USD each can generate 5-7 USD of dividends. And vice versa, even if the stock price is high, the percentage of dividend yield may look unattractive, however, expressed in money, it will be quite substantial. Anyway, it is up to the investors, which company to choose.