Dividends are cash payments to shareholders of a company and constitute an important source of income for investors. Dividend yield is a key metric that allows investors to compare stocks, trading at vastly different prices, in terms of their dividend generation capability. Investors seeking regular cash income from their stock portfolio need to understand dividend yield.
Dividends are cash payments to stockholders and are the primary way in which corporations shares their good fortune with their owners. Generally, a profitable firm pays out only a portion of its profits to shareholders as dividends and reinvests the rest into the business. This decision is entirely at the discretion of the board of directors. If the board deems it necessary to make a large investment to capitalize on an opportunity in the marketplace, it might channel all the profits back into the business and indefinitely suspend dividends. An investor must grasp the company's long-term strategy to understand its potential future dividend policy.
To calculate the dividend yield, find the dividend rate -- the sum of all dividends paid per common share over the last 12 months. Companies can make annual, semiannual or quarterly dividend payments resulting in one, two or four payments per year, respectively. If the firm pays dividends multiple times per year, add up the payments for the last year to find the dividend rate. If the firm makes multiple payments per year, add up the payments made over the last year. For example, assume that the firm has a quarterly payment policy and has paid three dividends of 30 cents and another of 50 cents over the previous year. The dividend rate therefore equals $0.30 + $0.30 + $0.30 + $0.50 = $1.40.
Dividend yield equals the dividend rate divided by the most recent stock price, multiplied by 100. If the stock in our example trades at $20 per share, the dividend yield is $1.40 divided by $20 times 100, or 7 percent. This means that for every $100 you invest in this stock, you can expect a cash income of $7 per year. By comparing dividend yields of different stocks, you can locate the best investment alternative. The formula uses stock price, which changes constantly. To find the right number, you must use the most recent stock price.
Sometimes companies end up with a windfall profit, which is a sudden influx of cash. To share this good fortune with stockholders, the corporation may announce a special dividend, also known as a one-time dividend. If, for example, the company sells its headquarters for $2 million and moves to a new building that costs half as much, it could elect to distribute some of the surplus cash from the sale in the form of a special dividend. Do not include such special dividends in your calculations, as they are unlikely to be repeated. If you were lucky enough to collect such a dividend, good for you. But if you are considering the stock as a future investment alternative, including such dividends will yield erroneous future projections and a less useful dividend yield figure.
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