Dividends, alongside capital gains, are the primary components of stock market total returns. Investors eagerly anticipate cash dividends from stocks at each payable date. Savers who plan budgets around dividend income must understand dividend payment schedules and dividend yield calculations. With this knowledge, investors can evaluate whether a prospective investment is a complementary fit within their overall financial plan. Conservative investors may prefer higher dividend yield stocks to generate investment income.
Return of Capital
Dividend payments are actually a return of capital back to shareholders. Strong companies may increase their divided payments each year, as profits improve. Shareholders will weigh the advantages of immediately receiving cash dividends against allowing management to reinvest money back into the business. Reinvesting capital back into the corporation may result in greater long-term capital gains. Dividend yield helps traders make initial dividend policy comparisons across the stock market and competing fixed-income investments.
Calculate Dividend Yield
Dividend yield is taken as a percentage, and divides a stock’s anticipated annual dividend by its current share price. Be advised that dividends are usually paid and quoted quarterly. As such, the announced quarterly dividend amount is to be multiplied times four before calculating dividend yield. For example, Stock Z trades for $100 per share and pays a 75-cent quarterly, or $3 annual, dividend. Stock Z would then feature a 3 percent dividend yield ($3 / $100). An investor could therefore expect to collect $300 in annual dividend payments, after buying into $10,000 worth of Stock Z.
Conservative vs. Growth Stocks
Large companies within established industries, such as banking, oil, and utilities generally carry high dividend yields. These businesses offer relatively few chances for significant profit growth, which means that investors are likely to demand that idle cash reserves on the balance sheet are paid out as dividends. Dividend payments from conservative stocks should buffer against market volatility amid recession.
Alternatively, small companies that operate within emerging business sectors pay minimal dividends, if any. Software, biotechnology, and alternative energy companies are more so focused on growth, and therefore reinvest most earnings into research and development, marketing, and equipment. Aggressive growth stocks typically perform well during a strong economy. Be advised that exceptionally strong performance of risky investments may signal the top of a stock market bubble.
Stock Dividends and Bond Interest
Contrary to interest payments on bonds, corporations are not legally obligated to pay out dividends. A corporation that defaults on its bond interest and principal payments is subject to litigation. Because of these terms, bondholder interest payments are prioritized above shareholder dividend payments. Be advised that quoted dividend payments and yield statistics may never come to fruition, if business profits deteriorate significantly.
Ironically, a high dividend yield may signal impending bankruptcy. Again, dividend yield is taken as a percentage and divides a stock’s expected annual dividend by its current share price. Therefore, a stock’s dividend yield would also increase dramatically amid sharp share price declines. At that point, the company is likely to reduce, or eliminate its dividend altogether.
Effective traders analyze annual reports before committing to any investment. Weak cash flow levels alongside high amounts of debt often foreshadow financial distress. Annual reports are available online through corporate investor relations departments and The Securities and Exchange Commission EDGAR system.