Key Dividend Concepts You Must Know
In this article to dividend investing, you’ll discover key terms and concepts essential for successful dividend investment strategies. Whether you’re an experienced investor refining your approach or just starting out and eager to grasp the basics, this article is crafted to demystify dividend terminology, unravel complexities, and equip you with the knowledge to confidently navigate the world of dividend investments.
- Dividend
When a company earns profits, it can choose to reinvest the money, pay off debt, buy back its own shares, or distribute profits to shareholders, which is known as a dividend. Dividends typically consist of a portion of the company’s profits or surplus funds. Shareholders receive dividends directly into their trading accounts, subject to a capital gains tax.
- Dividend Yield
The dividend yield represents the ratio between the dividend amount and the stock price. For instance, if a company pays a $2 dividend per share, and the share price is $100, the dividend yield would be 2% ($2 dividend / $100 stock price * 100). This metric serves as an indicator of the financial return investors receive relative to the stock price and their potential for profit from dividend income.
- Dividend Growth Rate
The dividend growth rate measures how quickly a company’s dividends increase over time. It indicates the annual change in the size of dividends paid to shareholders and is typically analyzed over one, three, and five-year periods. A consistently positive dividend growth rate can signal a healthy company, while a very low rate, especially below 2%, may indicate challenges in growth and dividend increases for investors.
- Payout Ratio
The payout ratio reflects the proportion of a company’s profits distributed to shareholders as dividends. It compares the total dividends paid to shareholders with the company’s net income. A low payout ratio suggests that the company retains more profits for growth or dividend increases, while a high ratio indicates a larger portion of profits allocated to dividends, limiting investment opportunities and dividend growth potential.
- Yield on Cost
Yield on cost measures the current dividend yield relative to the original investment cost. For example, if you bought a stock at $100 per share with an annual dividend of $2, the yield on cost would be 2% ($2 dividend / $100 stock price * 100). Over time, as dividends increase, the yield on cost also rises, reflecting the investor’s return on the initial investment.
- Amount
When a company distributes dividends, it specifies a fixed monetary amount per share rather than a percentage. As investors we are interested to check the percentage. The percentage is changing constantly because the stock price is changing constantly. The percentage can only change if a company increases or reduces the dividend amount, but it happens less frequently.
- Frequency
Companies determine how frequently dividends are distributed. Most companies distribute dividends quarterly. For example, Starbucks stock, with an annual dividend of $2.28 (in 2024), distributes this amount evenly over four quarters, resulting in $0.57 paid out per quarter.