I understand that specific lingo vocabulary can be useful for discussing the details of any specialty. However, for most new investors, dividend has something to do with a mathematical operation learned in grammar school, while yield is street sign. Put them together, and all I could originally conceive of was some magical force that was supposed to bring me happiness from stock market investments. After having it explained to me a few times and reading about it, I understand better than I had ever hoped when I was first overwhelmed by all the investor geek-speak.
A dividend that is paid out due to someone owning some shares of stock is called a dividend because it is technically
“a portion of a lump sum of money, hopefully profit, that is being divided up among many stockholders.“
However, the way dividends are evaluated and discussed brings several other terms into play. You can speak of
- Dividend yield
- Dividend growth
- Dividend rate
- Dividend ratio
- Ex-dividend date
My dad just spent the evening discussing dividends with me again. He is definitely a fan of investing in well established companies that have a solid record of paying out these dividends. But there is more to the picture than that. When he examines a company as a potential investment, he compares a couple different things about the dividends being paid.
First, lets review that the amount of a dividend, or the amount being paid to a particular stock holder, is dependent on how many shares of stock are owned. The amount of dividend per share may seem very low, such as 47 cents, but it adds up the more shares of stock that are owned. In essence, it is being paid for the right to use a person’s money in the company’s affairs. And companies that are managing their invested funds well can usually afford to give higher and regular dividend payments to stock holders.
In the dictionary, yield is defined first as something that is “produced” or “given in return.” It is only the second definition that refers to “surrender or giving way under pressure” (like on street signs…) It is obviously the first definition that is useful when talking of dividends, but specifically dividend yield is a term used to refer to the amount being paid in the dividend payment compared to what the individual shares of stock are currently being valued at. This makes the calculation of dividend yield not only variable as the market price (what people are willing to pay) for a share of the stock, but also something that is ultimately different for each investor, depending on what they originally paid for the shares of stock.
There is a simple division problem to figure out dividend yield. It is
the amount of the dividend divided by the price of the share of stock, or
d/s
in my short hand. Thus, if the current dividend being paid per share of a $30 stock is $1, the yield is
1/30 or 3.3%.
Keep in mind that the dividend amount is reported as an annual amount. But that is only a theoretical yield, because, as I said, it really depends on what was originally paid for the stock. If the shares of stock were purchased at $15 each, then the yield for that particular person for that payout is 6.6%, twice as high. If the market price of the shares keeps going up, it doesn’t really matter in terms of calculating yield if a person already owns the stock.
Since it is more fun to look on the bright side of things, consider the happy outcome if the dividend rate also goes up. A dividend rate is how the actual monetary amount of the dividend is spoken of, or the number in the numerator in the calculation above. So we could use the short hand of
dy=dr/sp (dividend yield = dividend rate/share price).
It is also given in yearly amounts, but often paid in quarterly time periods. So, going back to the previous amount, the dividend rate of $1 broken into quarterly payments would be 25 cents per share every 3 months.
Dividend growth is how any change in the dividend rate, or amount being paid, is going. The hope of any investor is that it will be always gradually getting higher. If it is changing too fast, it is usually a sign of instability or poor management. An exceptionally high dividend growth curve or change in rate, compared to the strong, established companies, is an indicator of higher risk. An investor should carefully look into what sort of risk that might be. Sometimes it is considered to be more typical for a certain kind of stock, say in some financial or real estate funds, but even there it is higher risk even if they are relatively stable companies in that category.
The dividend payout ratio is a comparison of the yearly dividend amount to the earnings “per share,” or
yd/es=dR (yearly dividend per share/earning per share = dividend ratio)
Again, my own short hand. Use what you will. I had already used the little “r,” so I used the big “R” this time around. It is just sometimes easier to see the math that is going on without writing out all the words.
One doesn’t have to do much study in accounting and financial statement reporting to realize that deciding what real earnings are is not a hard and fast fact. The numbers, even when presented honestly, are subject to much interpretation. Still, comparing dividend ratios over time can give an idea of how reliable the investment is, particularly if dividends are your main objective.
You can see that all of this can be examined on both a one time and an ongoing basis. There are charts and lists to be found that show how a company’s dividend habits have fluctuated over time. Some can also be found on morningstar.com on the free version, with more specifics available if you subscribe, as my dad does.
The last dividend term I listed was ex-dividend date. This is “the date on which the stock must be owned to receive the dividend payout for a given time period.” This not only means that if you buy after that date, you have to wait until the next payout, but if you owned it then, but sell it before the actual payment is made, you still get the dividend. This has happened to us a few times and is like one last little bonus. It might be something to take into consideration when timing the buying or selling of certain shares of stock.
Chance are that if you now go back and read a couple of my dad’s articles on financial freedom and dividends, you may understand them more. Wise investment will not guarantee perfect results every time, but it will lead to better results than a shot in the dark or wild spending and debt. Unless the government becomes significantly more economically cannibalistic or the world ends, but then that is another story, isn’t it?
