If you want to invest in order to multiply your money, that means that you’re likely interested in dividends. A dividend yield is a type of financial ratio that can help you understand how much money you could make off of a particular asset (like stocks, bonds, or CDs) compared to the cost of that investment.
To learn how to use this indicator of a stock’s health to make smarter investment decisions and how to calculate it, keep reading.
What is a dividend?
First things first, what is a dividend?
A dividend refers to the process through which a company gives cash, stock, or property to company shareholders. A company accepts investor’s money in order to grow and, in exchange, offers shares in the company itself.
When a company increases in profitability, it saves a part of its earnings for itself (known as retained earnings) and then gives some of its profits back to shareholders so that they make money too.
Dividends may fluctuate over time according to profits, company growth, and other factors. Depending on the company and its current performance, when those dividends are paid out also varies — some companies pay out dividends once every year, quarter, or month.
If business is bad, dividends may not be paid at all during a particular period (after all, companies aren’t obligated to pay dividends at all!).
But why do companies give away some of their profits to shareholders in the form of a dividend? It’s actually a smarter business move than it might seem. If shareholders of a particular company consistently make dividends (whether those come in the form of cash payments, more stock holdings, or other property), the company becomes a more attractive investment opportunity for others!
If more investors want to support a particular company because of good dividend yields, the company will have more capital to continue growing in profitability – a win-win situation for everyone involved!
How can I calculate a dividend yield?
A dividend yield is a financial ratio that lets you know how much you make in dividends compared to the price of a particular asset. Calculating a dividend yield is important because it can allow you to pick between stocks or other financial securities based on how much they pay you, monitor the health of the companies you’ve already invested in, and make additional financial decisions.
So how do you calculate it?
In simple terms, when calculating dividend yield, we want to know what percentage of the price you paid for a stock, bond, or another asset is paid back to you over the course of a year (this helps us understand how much we make off of that asset).
In order to calculate dividend yield, first add together the last four quarterly dividends that you received over the past year. Next, divide that total by the asset’s price. Finally, multiply that number by 100 to discover the dividend yield!
Consider this example. You own a stock worth $50 that has consistently paid quarterly dividends of 60¢. So…
0.6 / 50 x 100 = 1.2% dividend yield.
That means you’re getting a return of 1.2% of the stock’s price. Once you’ve calculated this ratio, you can use it to compare this stock’s dividend yields with those of others to see if you can find a more profitable investment opportunity or diversify your holdings.
Dividend yields are just one of the many figures you should take into account when deciding whether or not to hold on to a particular investment. For more investment and personal finance tips, check out the rest of the FlexAcademy library!