Dividends 101
At some point or another you may have come across a stock or mutual fund that pays a dividend. A dividend is a payment made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit, that money can be put to use in one of two ways. It can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders in the form of a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.
So what does this mean to you, the shareholder or investor who owns a stock in a corporation that declares a dividend? First of all it’s an excellent way to earn a secondary income. Because dividends are paid to you in the form of cash, you are able to generate an additional revenue stream throughout the year just by owning shares in the stock.
How much extra cash can I generate from owning shares in a stock that pays dividends?
A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. Let’s imagine that you owned 100 shares of ABC company which currently pays a dividend of $0.50 per share. This means that when dividends are paid to its shareholders, each shareholder is going to earn $0.50 for every share owned. So if you own 100 shares then you would receive a dividend check for $50 when dividends are declared.
How do I calculate the dividend yield?
To determine the dividend yield for ABC company you would simply calculate its share price by the dividend per share amount. Let’s again imagine that ABC Company is trading at $10.00 per share and you would like to determine the dividend yield. Take the dividend per share of $0.50 and divide it by the share price $10.00. In this case the dividend yield would be 5%.
Investing in dividend paying stocks are a great way to earn a profit above and beyond the capital appreciation generated from a stock. Let’s assume the share price of ABC Company was $10.00 when you bought 100 shares, and by the time you sold your shares they were worth $13.00 per share. That’s a 30% gain or $300 profit. But remember, ABC Company also declared quarterly dividends that year which means that you would have earned an additional $0.50 per share which in this case is $50. So the total realized gain is now 35% or $350.
Secure a secondary income with dividends regardless of the share price
Dividends are a great way for investors to secure a secondary income regardless of what happens to the share price of a stock. They are also a great way to hedge against the potential downturn in the markets. Let’s say that the share price of ABC Company went from $10.00 per share down to $8.00 per share. If you were to sell you would have realized a 20% loss, but if ABC decided to declare dividends at the same $0.50 per share, you would have received the same $50. The yield however would have increased to 9% ($0.50 / $8.00). You may have lost 20%, but at the same time you would have made up 9% in the dividend yield.
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