When you consider buying a stock, you may be thinking primarily about how likely a company is to grow, thus helping to increase the value of any shares you own. But another way you can benefit from stock ownership is through the payments many companies make to shareholders on a regular basis, known as dividends.
Many investors tend to overlook this feature of stocks, in part because a lot of companies don’t pay any dividends. They would rather re-invest their profits in the business instead of sharing them with stockholders. Their thought is that they can make better use of the money and provide their investors a payback by continuing to grow the businesses.
Other organizations, however - such as utilities and others not aiming for skyrocketing growth - attract investment by promising regular dividends to shareholders. So there are investors who look specifically for companies that are classified as “high dividend yield” stocks.
A “high” dividend stock refers to a company that is not only paying a dividend, but paying a higher dividend than many others. You can determine how much higher by dividing the annual dividend by the price of the stock, and this will give you the dividend yield.
As an oversimplified example, suppose Company A and Company B both paid $5 in total dividends last year on each share of their respective stocks. The difference is that Company A’s stock price was at $100, while Company B’s price was $50. Company B would represent a much higher dividend yield, at 10%, versus a 5% yield for Company A. So a $500 purchase of Company B’s shares would result in total annual dividends of $50, as opposed to just $25 in dividends for an equal amount of shares in Company A.
One way to determine the value of a stock’s dividend yield is to compare the rate to another standard, such as the interest rate on a 10-year Treasury bond, for example. Such a comparison would give you an indication of whether the stock’s dividend represents a higher payoff than you would receive on a bond or another instrument with a steady stream of payments. One thing a stock can do that a bond can’t, is offer more stock in the form of a dividend. Shareholders can add more shares to their holdings automatically, as a company rewards their investment with more shares of its stock. You need to keep in mind, though, that dividends are not guaranteed; they may be increased, decreased, or completely eliminated at any point.