Dividends are distributions from companies to shareholders. Although sometimes companies pay dividends in shares of stock, traditional dividends are made in cash, often quarterly. For some shareholders, a high dividend yield is the main reason they invest in a stock.
Understanding the true value of top dividend-paying stocks, however, goes beyond calculating dividend yield. Here’s a look at what you need to know about dividends and calculating dividend yield.
Dividend Yield Calculator
A company’s dividend rate is the amount of its payout. For example, if Apple pays a $0.63 dividend every quarter, its dividend rate is $2.52, or four times $0.63. But when it comes to dividend yield, the dividend rate is only half of the story.
Dividend yield is a ratio between a company’s dividend payout and its stock price. Because stock prices change with every trade on the market, dividend yield is also constantly changing.
To calculate dividend yield, take a company’s total expected payout over the course of a year and divide that by the company’s current stock price. The mathematical formula is as follows:
Dividend Yield = Cash Dividends per Share / Market Value per Share
Because dividend yield is a ratio, the same dividend rate can mean different yields for different companies. For example, imagine two companies, each paying a $1 annual dividend rate. The first company trades at $40 per share, whereas the next company trades at $20 per share. Calculate the yields on these companies by using the dividend yield formula:
Dividend Yield of Company #1 = $1 / $40 = 2.5 percent
Dividend Yield of Company #2 = $1 / $20 = 5.0 percent
To be entitled to a dividend, check the dividend calendar for a stock. You must own the shares before the ex-dividend date, which is when the stock trades without the dividend until the next quarter.
Dividend Payout Ratio
A company’s dividend payout ratio measures the proportion of its earnings that is pays out as dividends. A high dividend payout ratio is not necessarily a dangerous thing. Many of the highest dividend-paying stocks are companies with predictable revenue streams that pay out a high proportion of those earnings as dividends to entice investors. For other companies, however, a high ratio can portend trouble. If a company’s cash flow dips, it might not be able to sustain its dividend payout, resulting in a dividend cut.
Importance of Dividend Yields
Dividends provide peace of mind for some investors because the volatility of the stock market can be unsettling. The top dividend stocks provide investors with cash returns every year, regardless of the company’s stock price performance. Dividends also provide a hedge against inflation because the dividends of reliable companies tend to increase over time.
Dividends can also provide payback of an original investment over time. For example, if you buy a share of stock for $40 and that company pays a $1.20 dividend, you’ll get your entire investment back in about 33 years. If that dividend grows 5 percent per year, you’ll be made whole in just 20 years, even if the stock price goes to zero.
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