Most people who invest in the stock market focus on price appreciation--that is, whether the stock price goes up or down. But there is another way to make money from owning stocks--through dividends. Stocks that pay a dividend are called income stocks. The dividend yield gives some insight as to how much income shareholders receive and whether the company pays a dividend at all.
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A dividend is a payment made to shareholders. Dividends allow shareholders to earn returns on stock, aside from stock appreciation or growth. For this reason, some investors prefer stocks that pay a dividend.
Not all stocks pay dividends. Yahoo, Google and Apple, for example, have never paid a dividend. Some companies have decided it is more beneficial to investors in the long run to reinvest profits back into the company.
Dividends are usually paid quarterly. They are expressed in per-share amounts.
The term "yield" refers to the income paid on a financial investment. Dividend yield tells an investor how much shareholders receive in cash payout as compared with the share price. It is expressed in terms of a percentage. This number allows shareholders to look at stocks and decide which ones will produce significant income.
The dividend yield can be calculated as the amount of dividend (annualised) divided by the share price. Since dividends on common stocks are not guaranteed, the dividend yield calculation uses historical dividends in the numerator.
Consider this example: the IBM corporation pays its shareholders a quarterly dividend of 40p per share. This equates to £1.60 annual dividend. If the current share price for IBM common stock is £88, then the dividend yield would be 1.9 per cent.
Dividend yields for most companies are under 2 per cent. A dividend yield that is much higher than that number may be a bad sign. It could mean that the company is paying out too much of its profits to its shareholders.
The significance of dividend yield comes when investors are trying to put together a portfolio with specific income goals. Some investors don't care about dividends and are simply looking for growth. These investors don't look at dividend yield as much. Other investors are looking for income-producing stocks, perhaps if they need a regular distribution of cash from their portfolios. For example, a charitable foundation or university endowment might invest in some stocks with dividend payouts in order to have a steady source of cash for grants or scholarships.
The dividend yield gives an indication of yield based on past dividend payouts. Historical dividend yield is a reliable source of information about a company's likelihood of future dividends--but not always. Some companies pay dividends for years and then announce that they must stop.
Though this article only pertains to common shares, preferred stocks pay dividends as well. The yield is calculated the same way.
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