More About Dividends

What Are Two Main Types Of Dividend Policies?

Cash dividends,  are those paid out in currency. This is the most common method of sharing corporate profits with the shareholders of the company.They are form of investment income and are usually taxable to the recipient in the year they are paid. For each share owned, a declared amount of money is distributed. So if an investor owns 100 shares and the cash dividend is $1.50 per share, the holder of the stock will be paid $150.

 
Stock or scrip dividends are paid out in the form of additional stock shares of the issuing corporation instead of paying in cash.They are usually issued in proportion to shares owned (pro-rata). If the payment involves the issue of new shares, it’s same as stock splits, which will cover later, in that it increases the total number of shares while lowering the price of each share without changing the market capitalization of a company.

Ratios Commonly Used To Gauge The Sustainability Of A Firm's Dividend Policy: Dividend Cover And Payout Ratio:

 
Dividend cover of a company is important factor to understand about an investment, and see if a company has a stable payment policy. Do they increase their payments in an orderly and regular way, are payments made at a constant rate and will the firm be able to maintain these payments? 

 
One measure used to help answer these questions is a ratio known as dividend cover:

 
Dividend Cover = Earnings Per Share divided by Dividend Per Share

 
The inverse of this ratio is the proportion of earnings that belong to ordinary shareholders which are distributed to them, better known as the dividend payout ratio. If a company has a dividend cover ratio of 1.0, it pays out all earnings in dividends. This means that should earnings fall, the company might be forced to cut annual dividend payments. 

 
Many firms use annual dividend payments as a signal to shareholders and the market of confidence, so in the short term, directors will be reluctant to reduce payments, unless the firm is in trouble.


How Is Dividend Yield Calculated?

Dividend yield is used for comparing the relative attractiveness of various income stocks, or stocks that pay dividend. It tells you, in a percentage terms, what you can expect to profit in a year if you buy that stock. It is useful because it allows us to compare it, not only with other stocks, but with other investments such as bonds or certificates of deposit.

 
Formula is: Dividend yield =  Annual dividend / Current stock price. 

 
So if company has a price 20$/share and it pays 2$/share dividend, dividend yield will be: 2$ / 20$ = 10%.