What a dividend is
A dividend is a share of profit a company pays to its shareholders, usually in cash and usually every quarter. Not every company pays one. Many fast-growing companies keep the money to reinvest in the business, while mature, steady companies often pay regularly.
Dividend yield
Yield is the yearly dividend per share divided by the share price. If a stock pays $2 per year and trades at $50, the yield is 4%. The example is only an illustration.
Because price is in the bottom of the fraction, yield changes every day as the price moves. A stock whose price falls sharply will show a higher yield even if the dividend has not changed, which is why a very high yield can be a warning rather than a gift.
Payout ratio
The payout ratio is dividends divided by earnings. If a company earns $4 per share and pays $2, the payout ratio is 50%. A low ratio leaves room to keep paying if profits dip. A ratio near or above 100% means the company is paying out as much as, or more than, it earns, which is usually hard to keep up. For some industries such as real estate trusts, other measures of cash flow are used instead.
Important dates
- Declaration date: the company announces the dividend.
- Ex-dividend date: you must own the stock before this date to receive the payment.
- Payment date: the cash arrives in your account.
Dividends and total return
Your return from a stock is the price change plus any dividends. A company that pays a dividend is not automatically a better investment than one that does not, because the price usually drops by about the dividend on the ex-dividend date. Many investors choose to reinvest dividends to buy more shares, which feeds compounding.
Dividends are generally taxed. How they are taxed depends on your country and account type, so check with a tax professional.
Quick answers
Is a higher dividend yield better?
Not necessarily. A high yield can signal that the market doubts the dividend will last. Look at the payout ratio and the company’s cash flow.