The financial ratio reflects the amount a company pays in dividends relative to its stock price. Investing in a reputed or mature company is advice often given to beginners in the stock market. But why is it so? Firstly, these companies provide a steady generation of income through returns and secondly, they pay dividends to their shareholders each year.
Understanding dividend yield, factors affecting its value and how it can benefit an investor is an essential part that beginners must get a strong grip on.
Understanding Dividend Yield
Let’s begin by understanding what dividend yield is in simple terms. Dividend yield is the amount of money a company pays to its shareholders, each year from the company’s profit.
This is given as a token of appreciation and building a better market image for the company. A dividend yield can be shown in any form including actual money, additional shares or other securities.
A company offers dividend yield to its shareholders depending on the shares they hold in the company. So for investors, it becomes crucial to understand what they can earn in the form of dividends for every penny invested in buying shares of the company.
Here’s how dividend yield is calculated:
Dividend Yield = Price Per Share/Annual Dividends Per Share. Investors can also use a dividend yield calculator online.
Let’s take an example to simplify dividends further yield: Say a company has its share prices valued at 50 and it is paying 1.50 per share. To get the dividend yield, the dividend amount is divided by its share price i.e 1.50/50= 0.03
What Affects Dividend Yield?
The dividend yield paid by a company is affected by several factors that can be evaluated to get an overall idea of the possibilities. These factors include:
1. Stock Prices
A simple rule of dividend yield says that as the stock prices rise, the dividend yield falls. However, this is not a negative movement as investors can continue making profit from the rising stock prices.
2. Debt and Liquidity
Companies with debt are under the burden of repaying the borrowed money that stops them from offering dividend yield.
3. Industry Trends
A company before deciding to offer dividend yield will gauge the policies of other companies in the same sector and decide based on the common dividend yield practices.
4. Rules and Regulations
Paying dividends has to be done under certain rules and regulations. For instance, offering a dividend comes under tax implications that the company will evaluate before making a decision.
Dividend Yield: Exploring the Pros and Cons
With a fundamental understanding of dividend yield and margin calculator, let’s take a look at its pros and cons:
Pros
1. Amplify Returns for the Company
Every dividend that the company pays out to its shareholders is done with the underlying hope of investors reinvesting the money in the company’s shares.
2. Indicates Company’s Financial Health
A company paying out dividends is also a reflection of their good financial health making it a reliable factor for investors to decide on their investment.
3. Boost Shareholder’s Confidence
A company paying steady and regular dividends is an indicator of the management’s confidence in its plan that in return boosts the shareholder’s trust in the company.
Cons
4. Might Stunt the Company’s Growth
Dividends are paid to shareholders from the company’s profit. This also indicates that the company is not putting in that extra money in expansion and development strategies that might stunt its growth.
5. Chances of an Elimination
Dividends are not an obligation on the company so there are high chances that they eliminate the practice of providing dividends at any given point. Additionally, these are highly volatile resulting in unstable dividend yield.
6. Downtrend with Appealing Dividend
Relying solely on the dividend yield of a company is not a smart choice because in many cases even a downtrend in the company’s actual health can be accompanied by appealing dividends. This is because the stock prices are the denominator of dividend yield forcing the latter to reflect higher value even when there is a downtrend.
Wrapping Up
Dividend yields are a reliable source of income generation for investors who are either new or wish to stay in for the long run and earn returns against volatility and inflation.
However, as a beginner relying solely on dividend yields paid by a company to analyse its financial health is not something we recommend.
Remember that not every company offers dividend yield and even when they offer there are multiple factors affecting its value that you must gauge smartly.
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