How is dividend calculated?

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How is dividend calculated?
The dividend is a shareholders portion of a company's profit. (John Foxx/Stockbyte/Getty Images)

Dividends are payments in cash or stock made to shareholders of a company. A dividend may be declared (authorised by the company's board of directors) or it can be a guaranteed fixed rate in the case of preferred stock. Strictly speaking, dividends are issued, rather than calculated. However, investors calculate dividend yield, payout ratio and the amount of income a particular stock provides as part of analysing a stock's performance. Knowing the return dividends provide is a major concern for stockholders who are primarily interested in income-producing investments. Investors whose investment strategy is aimed at equity growth tend to place less importance on dividends. The first step in analysing a company's dividends is to find how much income the dividend represents. All that's necessary is to multiply the number of shares by the dividend amount per share. Dividends are normally paid quarterly. Divide by 4 to find the income that is paid every three months. For example, if you have 800 shares of stock that pay an annual dividend of £1.30 per share, the annual income is 800 times £1.30, or £1,040. Divided by 4 this comes to a quarterly payment of £260.

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Yield

To figure yield, divide the dividend amount per share by the price paid for a share of the stock. For instance, if the stock was purchased for £16 per share and the dividend is £1.30 per share, the yield is £1.30 divided by £16 or 0.08 (8 per cent). Investors find dividend yield useful when comparing the income potential of a stock to other securities such as bonds or CDs.

Payout ratio

The dividend payout ratio is the ratio of how much profit is paid in dividends compared with the total profit earned by the company. Divide the earnings per share (which tells you how much profit per share the company made) by the dividend per share. For instance, if earnings per share are £1.30/50 and the dividend is 30p, the dividend payout ratio works out to 5:1. A high payout ratio indicates the company is retaining most of its profit (usually to expand or pay off debts) while a low payout ratio shows the company is devoting much of its profit to paying dividends.

Stock dividends

Sometimes a company issues additional shares to stockholders in lieu of a cash dividend. This can allow a company to issue a dividend while retaining cash profits to reinvest. Since the stock may appreciate it may also be a good deal for investors, especially with growth-oriented companies. A company might issue a 4 per cent stock dividend, for example, by giving each stockholder an extra 4 shares for every 100 shares owned. To find out how much the dividend is actually worth, multiply the number of shares by the market price of the shares. If the stock is selling for £16/share, that 4 per cent dividend would be 4 per cent of £16, or 60p per share.

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