Dividend Yield | Definition/ˈdivəˌdend ˌyēld/
the excess cash a public company pays per share to its shareholders.
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As a beginner in the investing world, it can be challenging when trying to determine what type of stocks to purchase. Research is crucial to ensure you pick the right stocks based on your investing preference. A critical financial statistic that helps investors make profitable returns from their investments is the dividend yield.
What is a Dividend Yield?
The dividend yield is known as the excess cash a public company pays per share to its shareholders. Many well-known investors, such as Kevin O’Leary, Warren Buffett, and Tim Cook, hold a large sum of dividend-yielding stocks, which helps them earn a passive income each quarter.
Although the average investor does not have the same level of wealth as these billionaires, you could use the dividend earnings to reinvest into the company and purchase additional shares, increasing your net worth and portfolio value, or put the dividend earnings in your savings account.
How Do Dividends Work?
When investors earn dividends, it means that companies decide to share the profits with their investors. The dividend per share can be calculated by multiplying the dividend yield percentage posted on Bloomberg or Yahoo! Finance by the company’s current share price. This value will calculate the annual dividend per share.
However, as companies issue dividends every quarter, take the estimated yearly dividend and divide by 4. This computed value is the amount of money the company will give per share. Here’s an example to help better understand:
In the example above, the TD Bank stock has a share price of 75.19 as of 2021/11/24. According to Google Finance, the dividend yield is 3.35%, meaning that 3.35% of the current share price is the amount of money a shareholder will receive for the year.
When you multiply the dividend yield percentage and the share price, you receive a shareholder’s income per share of 2.52 USD. As this value is how much an investor receives annually, dividing it by 4 will give the quarterly dividend income of 0.63 USD.
The Difference Between a Dividend Rate and Dividend Yield
Although these terms seem similar, there is a major difference between them. First of all, the term dividend yield refers to the actual percentage listed under sites such as Google Finance, Bloomberg, or Yahoo! Finance.
Per the graphic above, these percentages indicate the dollar portion of the current share price given to investors annually. The amount that is distributed to investors is called the dividend rate. The dividend rate is the amount paid for each share outstanding, and the more shares an investor has from one company, the more dividend income they are entitled to receive.
Are Companies Forced to Pay Dividends?
Companies are not forced to issue and pay dividends. Typically, smaller companies, or those in the growth phase and are looking to increase their market share, will not do so as they want to keep their profits and reinvest it in their business to help them obtain a higher stock price.
Why Do Companies Pay Dividends?
Companies pay a dividend at the end of every quarter to reward investors for holding onto their shares. When companies offer dividends to their shareholders, it increases the demand for their shares, causing their price per share to increase.
Typically, when shareholders receive income from their stock market investments, one popular way to utilize the additional income is to reinvest the money back into the dividend issuing company stock. By investing the dividends received into the same company, the investor will increase their dividend income at the end of each quarter and ultimately at the end of the year.
Benefits of Investing in Companies that Pay Dividends
There is a famous quote by Warren Buffett, “If your salary is your only source of income, you're one step away from poverty.” This quote was showcased during the pandemic when many people had to rely on COVID-19 relief programs and their savings to help them accommodate their living expenses until they could go back to their job or find one with a similar pay level.
Thus, it is essential to invest in established companies that issue regular dividends to maintain a steady stream of passive income and a secondary source of income.
Furthermore, the main benefit of dividends is the number of shares you hold in a company dictates the amount of dividend income you receive. The more shares you own within a company, the higher your cash flow at the end of each quarter, as the dividend amount is given out at the end of each month is for each share outstanding, not the number of shareholders that hold the shares.
The best example of this is Warren Buffett, one of the world’s wealthiest businessmen, with a net worth of 102.1 billion USD. One of Warren Buffett’s most significant investments is in Coca-Cola (NYSE: KO), in which he holds 400 million shares, making his investment worth over 22 billion USD. From this long-term investment, Buffett makes over 600 million USD annually in dividend income from his position in Coca-Cola.
Thus, when investing a significant amount of money into a profitable company that issues dividends, over time, you will receive an increasing amount of money each year via dividend income. Below are a couple of examples of established companies that offer dividends to their shareholders.
Disclaimer: The information explained in this Money Meaning should not be considered as investing advice. Always do your research before investing in any stock.