How Are Dividends Calculated?
How Are Dividends Calculated?. Dividends are the means by which companies distribute profits to stockholders. The amount of the dividend is of primary importance to investors seeking income from stock investments. Other investors interested in equity growth may be satisfied with low dividends or none at all, if the company is showing strong growth. Strictly speaking you don't calculate a dividend since it's declared by the company's board of directors. However, there are a several measures of dividends that are calculated, which you can use to evaluate the income value of a stock.
Dividends are primarily either paid in the form of cash or stock. A cash dividend is pretty much what it says. The company makes a cash payment (usually quarterly) to stockholders based on how many shares they own. Stock dividends, on the other hand, are new shares of stock that are issued to stockholders instead of cash. They can be held in an investor's portfolio or sold for cash. When you calculate dividend measures, you use different methods for cash and stock dividends.
Investors often want to know the yield (rate of return) dividends provide, especially for preferred stock that pays a fixed dividend rate. To calculate dividend yield, divide the annual dividend payout by the price you paid for the stock (not the current price) and express it as a percentage. You can use the yield to compare the income producing value of the stock to that of bonds or other income securities. For example, if the annual dividend is $2.40/share and you paid $30/share, your yield is $2.40/$30.00 or 0.08 (8 percent).
Dividend Payout Ratio
An important consideration is how much of the company's profit is being paid out in dividends and how much is retained to invest in expansion. The dividend payout ratio is simply the amount of profit divided by the amount of the dividend. Usually this is calculated by dividing the earnings per share by the dividend. A high dividend ratio indicates most of the company's profit is being reinvested in future growth. A low dividend payout ratio means the stock is producing good income, but isn't likely to grow rapidly in value. As an example, if the earnings per share are $2.00 and the annual dividend is $0.80, the dividend payout ratio is $2.00/$0.80 or 2.5:1.
There are a couple of other calculations stockholders may want to make using dividends. One is to figure out how much you can expect to be paid. To find the annual payout, multiply the number of shares you own by the annual dividend rate. If you want to know the size of the quarterly payment, just divide by 4. For instance, if you own 1,000 shares of stock with an annual dividend of $1.20/share, your annual income from the stock is 1,000 times $1.20, or $1,200 and your quarterly payment will be $300. You can also use the method in the "Yield" section above to determine the likely yield of a potential investment. Simply use the market price you expect to pay for a stock to calculate the potential yield.
Calculating stock dividend measures is different since there is no cash payout. This also means the dividend payout ratio is meaningless for stock dividends. However, you can calculate yield. Calculate the total cash value (based on the current market price) of the shares issued as the dividend. Divide this by the price you paid for the stock. For example, assume you own 1,000 shares of stock purchased at $25/share and you are issued a 5 percent stock dividend (equal to 50 shares). If the current market value of the stock is $40/share, the cash value of the dividend is $2,000 (50 shares times $40). That works out to $2/share for your original 1,000 shares. Since you paid $25/share for the stock, your yield is $2/$25, or 0.08 (8 percent).