Equity purchases attempt to earn profit from share appreciation and dividends. You can orient your investing by sorting the equities into specific equity categories that meet a specific objective. The Growth and Value Equity category attempts to earn return primarily from share appreciation. The income equity category attempts to earn return from dividends. You can then analyze the firms you purchase to determine which fits your objective for investment based on their sorted category.
Dividends are payments that firms give shareholders based on their ownership of shares. If you own shares of a firm, you may receive an annual payment from their firm’s leftover profits from the year before. There are two types of dividend that you can receive from the firm. You might receive a cash payment from the firm, which is known as a “Cash Dividend”. The benefit to a cash dividend is that it is a liquid payment which can be used however you wish. You could also receive additional shares, which are known as a “Capitalization Issue” or a “Share Dividend”. These additional shares must be sold in order to convert them to liquid cash, but can also increase or decrease in value with their other shares.
Dividends payments are a boon to your shareholder returns. You earn money from the price appreciation of shares, and you also earn additional cash from dividends. The larger dividend payments result in higher returns for you. You should realize this, and include dividends in your appraisal of share prices.
The establishment of a dividend (It is not required) results in a boost to share prices. An increase to dividend payments also results in higher share prices. Decreases or termination of dividends reduce share values.
Dividends and Company Finances
Dividends, like stated earlier, are paid out of leftover profit. An establishment or increase of dividends implies the firm is doing well and has excess earnings. Lowering or cancellation of dividends implies the firm is doing poorly or expects to do poorly in the future. In all cases, review the firm’s income statement and ensure that the firm can afford dividends. Otherwise payments actually hurt your investment long term and you could consider selling out (preferably after the newest round of dividends are paid).
Firms which are stable while paying high dividends can qualify as Income Shares, but this requires stable growth or earnings. If the firm cannot afford to pay dividends, it shouldn’t be considered an income share even if dividends paid are high. The return is unsustainable and could, or should, be cancelled at any time.
There are many cases where a firm should not pay dividends. If a firm is encountering market difficulties, has falling sales, or rising costs, it may need to cancel or reduce dividends to ride out the storm easier. If a firm is young and struggling to adapt or grow, it should not be giving away reinvestment funds. If management is giving away large dividends while flirting with financial disaster, it shows a bad set of priorities or weak management. Occasionally, greedy shareholders will demand dividends when the firm is weak and cannot afford to pay them. Responsible management should not cave by paying or increasing dividends when the firm is financially imploding.
Since dividends are paid to share owners, there are calendar limitations to dates for dividends. Dividends are paid to you on a specific date. To receive a dividend, you must have purchased shares before the cutoff date, called the “ex-dividend” date. The ex-dividend date is 3 days before the dividends are paid.
Dividend yield is a tool that shows dividends as a percentage of the current share price. The equation is very simple:
If the dividend paid to you rises, or the share price decreases, the dividend yield increases. If the dividend paid to you falls, or the share price increases, the dividend yield decreases. The dividend yield changes with each day, since the dividend yield takes current market price of a share into account for the calculation. You should primarily concern yourself with the current price for shares you are considering purchasing. If you already own shares, you should not be concerned with Current Price per Share. Instead, use the purchase price of your shares. Your calculation of dividend yield appears as:
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