There are so many indicators out there that sometimes it is difficult to answer the simple question, "How Dividend is Calculated." If you want to learn how to calculate the money to be received from your dividend investment, then this article is for you.
Here, I will help you understand how to figure out your dividend income and how to navigate through the basic terms of dividend investing.
If you are not sure yet if a dividend investing strategy is what you need, then I invite you to read one of my previous articles:
Discover Why Dividend Income Can Be The Best Way To Your Prosperity
Yield or Dollars? What Do Companies Actually Pay?
I think this is one of the very first confusions of beginner investors. Let's bring some light.
The companies do not pay a yield. They pay a defined dollar amount.
Let's see an example.
Altria Group (MO) pays an annual amount of $3.92 per share. That means you will receive annually $3.92 multiplied by the number of shares you own. (Unless they decide to grow or cut it, of course).
The Dividend Yield of 9.48% is then a consequence of that payment when divided by the current stock price ($41.34).
Putting it in different words.
That means when planning your dividend income, you should consider the Annual Payout. This is what you will actually receive in your pocket, and it is constant once it is declared until the next update, i.e., it varies not very often.
The Annual Payout tells you if you can afford your summer vacation in the Bahamas out of your dividends.
In contrast, the Dividend Yield is a relative metric that illustrates the profitability of your investment. It varies on a daily basis as the stock price does. If the stock price goes down, the yield increases for the same payout, i.e., it becomes more attractive in terms of return on investment.
The Dividend Yield tells you if your dividend income is worth the money you invest in purchasing the stocks.
To picture the difference in volatility between the two, see the two images below.
MO Dividend Payout History. Source: SeekingAlpha
MO Historical Dividend Yield. Source: SeekingAlpha
As you can see, the Dividend Payout stays constant between different quarters and increases only when it is redeclared, while the Dividend Yield varies every day as the stock price fluctuates.
Now, you know how to plan your dividend vacation and how to assess the rentability of your investment. It was not complicated at all.
Factors Influencing Dividend Payments
Once you purchase a stock, you become eligible to earn its dividend payments; you are all set. Independent of the stock price variation, you will receive the declared dividend amount. This is why dividend investors worry less about stock price fluctuation, or they are happy when a stock goes down because they can buy more shares.
However, there is still one variable: the decision about the dividend payment. If the company you invested in decides to raise its dividends, you will automatically receive the higher amount. On the other side, if the company decides to cut its dividends, that will be directly visible in your payments as well.
There are several factors which influence the company's decision to pay dividends.
Company Earnings
This is straightforward. In order to pay a dividend, the company has to earn money. It could finance the dividend payments by issuing debt or paying them out of the cash reserves. Both of them are unsustainable. In other words, the dividend payment has to be well covered by earnings.
If a dividend is not well covered by earnings, there is a risk the company will cut the dividend. On the opposite, if a company has good earnings, it is likely to continue to pay dividends or even raise them.
An example of an overpaying company is NextEra Energy Partners (NEP), which is currently trading at a super-attractive 12% dividend yield. It has been paying dividends higher than its earnings for a couple of quarters already.
NET Dividend vs Earnings. Source: SeekingAlpha
(Quick Note: EPS = Earnings per Share)
NEP became so attractive after its recent price drop. It is up to you if you want to invest in it, but you should understand the risk of the dividend stability.
A key term here is Payout Ratio, which we will address in a separate article.
Dividend Policy
Every dividend payment is a cash outflow from the company. This is cash that could have been used for another purpose, for example, building new facilities. Therefore, each company establishes a so-called dividend policy, i.e., how much of the earnings it considers to pay as dividends so that it has enough money left to finance its other operations.
It is difficult to have both growth of the company and a high dividend; thus, each company finds its balance between the two.
An example of a company with a limited dividend policy is Apple (AAPL). Although Apple is very profitable and earns about $1.47 per share, it pays only $0.24 as a dividend per share. This is, of course, due to the company's growing vision.
AAPL EPS vs Dividend. Source: SeekingAlpha
Industry Trends
Naturally, the most common case is that well-established and mature companies focus on dividends, while younger companies are more focused on growth.
It is not hard to realize why. A young company is usually barely profitable and has to re-invest all its resources into growth, consolidation, and optimization, while a mature company does not have all these growth-associated costs and can reward its shareholders by sharing the profit.
It is similar to human life if you think about it. As children, we usually only consume resources to grow and learn. It is only afterward that our knowledge and abilities start to generate an income.
Speaking about industries, it could be interesting to visualize the average dividend yield per every sector. That way, we can easily spot opportunities when analyzing companies from a particular sector.
Here we go:
Consumer Discretionary: 1.25%
Basic Materials: 2.11%
Financials: 2.10%
Real Estate: 3.75%
Communication Services: 1.27%
Information Technology: 1.36%
Energy: 3.35%
Industrials: 1.97%
Consumer Staples: 2.72%
Healthcare: 1.82%
Utilities: 3.07%
Dividend Yield by Sector
Surprisingly or not, the winner is the Real Estate sector, followed by Energy and Utilities. By having this information, you can evaluate if a company looks like a great opportunity or if it is average for its sector.
In general, it is a good practice to compare companies to their peers or sector/industry averages.
Conclusion on How Dividend Is Calculated
I hope the article helped you understand how the dividend is calculated. My highest aim was to show you the difference between Dividend Yield and Dividend Payout. I am sure it is more clear now that the company decides what dividend amount to pay in cash and that the dividend yield is a consequence of that amount and the share price.
Also, I am confident you understood the basic factors that drive the decision about dividend payment and how to possibly identify risky investments. There will be many more articles about risk mitigation, so make sure you are not missing any of them. Subscribe to get notified about new content and get your Guide to Financial Freedom for FREE.
I wish you reach your Dividend Horizon,
Alexandru Artenie
FAQ about Dividend Calculation
What is the Dividend Yield Formula?
To calculate the dividend, you have to apply the following formula:
Dividend Yield = Annual Dividend Payout ($) / Share Price ($) * 100%
Note that the Dividend Yield varies on a daily basis together with the stock price fluctuation, while the Dividend Payout is usually declared once every quarter.
When is the Dividend Calculated?
The dividend to be paid out is usually calculated once every quarter. It is then made public on the dividend declaration date. At the same time, the ex-dividend date and the payout date are communicated to the shareholders. Note that you do not necessarily need to own the stocks at the declaration date to receive the dividend. Instead, you should own it before and during the so-called Ex-date.
How to Calculate a Dividend Payout Ratio?
To calculate the Dividend payout ratio, you have to divide the earnings per share (EPS) by the dividend per share:
Payout Ratio = Earnings per share / Dividend per share * 100%
The higher the payout ratio, the riskier the investment is, as the dividend payment might be unsustainable if it is too high or exceeds the earnings. Most commonly, a dividend payout ratio of up to 60% is believed to be good.
