Securities For Beginners

Thursday, February 02, 2006

A rundown on dividends

First of all: What are dividends?
Well, it's pretty simple: Dividends are a portion of a company's profit paid to the shareholders - who are the owners of a company - in order to let them participate in the company's (financial) success.

Here's a rundown on dividend information provided by most stocktables:

Dividend paid
The dividend paid to the shareholders in the last year - most often expressed as dollar amount paid per share. Nothing exciting about this term, it only tells you wether there was paid a dividend at all or not (for example because the company didn't generate a profit or the profit is reinvested in order to generate growth). Most of the big and stable companies pay dividends whereas fast-growing companies often reinvest the profits in order to keep the company growing.

Dividend yield
The dividend yield is much more interesting for the average investor than the mentioned absolute amount paid: It shows you the dividend per share in relation to the stock's price. Calculation is very easy:
Dividend yield = Annual dividend per share / Current stock price

High dividend yields are always welcome because they provide an income stream even if the stock price isn't developing very well.

Dividend payout ratio
The actually paid dividends in relation to the company's profit. There are two different ways to calculate the payout ratio although there are equivalent (so it doesn't matter which one you choose):
Payout ratio = Dividend per Share / Earnings per share


Payout ratio = Dividends / Net income

The payout ratio gives you a rough idea of what the company is doing with the profits: Keeping it in the company or paying it to the shareholders?

Company X:
Stock price: $40
Earning per share: $4
Dividend per share: $2

Divdend yield: 0.05 (2 / 40) or 5%
Payout ratio: 0.5 (2 / 4) or 50%


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