Introduction to Dividend Yield.
Dividend Yield is used for the valuation of a company. This calculation is readily available.
Before learning dividend yield, first, we need to understand the following points.
What is a dividend?
The dividend is a reward or return given to investors from the profits of a company.
Paying of Dividend.
Paying dividend or not is the Board of Directors (BOD) decision. It’s not compulsory for a company to pay a dividend.
Dividends are proposed by BOD & approved by shareholders in the Annual general meeting (AGM).
In India dividend is a tax as per the Income Tax slab rates.
Example:- If a person’s income is 20 Lakhs per annum & he receives 1 lakh of dividend income.
Then, 30000 will need to be paid as capital gain tax. (Assumed Figures).
A company announced a 200% dividend
What does it mean?
When a company issue shares they are issued at face value. Also called a nominal value.
Price of a share = 1000 & Face value per share = 10
Dividend = 10*200/100 =20.
Also Read: What is the Debt to equity ratio?
What is a Dividend Yield?
The Dividend Yield is a financial ratio that measures the annual value of a dividend received as a percentage of the current market share price of a security.
In other words, div. yield means how much of a percentage of the market share price is paid to investors in the form of a dividend.
Dividend Yield Increase.
Determining the cause of dividend yield is increase is important, the following can be two reasons.
– Fall in the share price.
When the share price of a company falls due to any reason the div. yield increases.
Example:- Co. 1 from the above example, if the share price goes down to 500 from 1000; then the div. yield be 6% (30/500*100).
– Company increase in the dividend.
Companies also increase dividend Y-o-Y basis because of sales & profit increases which can be also a reason for dividend yield expansion.
Doing the homework on the cause of div. yield increases are essential.
Be aware of financial engineering
Example:- A company is heavily leveraged & still paying out heavy dividends which it can’t afford.
-Small companies v/s Big companies.
Smaller companies may not pay a dividend as they can reinvest these profits to expand their business & give a return in the form of capital appreciation.
Capital appreciation means an increased market share price.
Big companies are well established & they do not have further room to grow. Thus they are unable to reinvest profits & pay out them as dividends.
Therefore the yield depends on the business life cycle of the company.