Dividend and dividend yield, although related, is not one and the same. Dividend is the portion of profits that a company distributes among its shareholders in the form of cash. It is expressed per share or as a percentage of the share's face value. In case a company declares a 10-percent dividend on Rs 10 par value share, you will get an amount equal to the face value of the share multiplied by 10 percent - Re 1 - as dividend. In case the dividend is expressed in percentage terms, it is the percentage of the face value of the share.
Nowadays, dividends are tax-free. The company pays dividend distribution tax before distributing dividends.
Dividend yield is different. It is the ratio of dividend amount per share to the prevailing market price of the share. This is a yardstick to identify attractively-valued stocks. Normally, higher the dividend yield, more attractive is the stock for investors.
The dividend yield indicates the percentage of an investor's purchase price of a stock that is repaid to him by way of dividends. Absolute amount of dividends do not count for this comparison. Many investors who want a regular income through dividends look for stocks which either maintain a steady or an upward trend of dividend declaration. They invest in scrips having a high dividend yield. Ideally, a low market price combined with high dividend payout gives a high dividend yields. Dividend yield is a simple tool for any investor to evaluate his investments in scrips and to choose the right portfolio depending on his priorities
Before investing in a stock with a high dividend yield, you should check out the dividend paying history of the company in the past. Whether this is a regular dividend paying stock or is it just a onetime pay-out is significant.
You should also be aware of the source of the dividend - whether it is paid out of a previous year's profits or out of profits earned from non-operating activities such as sale of assets etc. Investing on the basis of dividend yield is a popular practice in developed markets. Dividend yield can be a good tool to identify an undervalued stock that may offer good appreciation. You can invest in equity and equity-related instruments of companies focusing on dividend yields. An equity portfolio should have stocks that are available at attractive dividend yields.
Under the Income Tax Act, dividend is tax-free. The company pays dividend distribution tax. In the hands of investors, this is a tax-free income. So the effective return for the investor will be more than the dividend yield - the exact yield will depend on the tax bracket of the investor. Thus, the effective yield for an investor in the highest tax bracket is even better.
While investing and building a portfolio, you should look for companies that have a record of consistent dividend payments. Some companies follow a policy of progressive increase in dividends. These are even better investment options. However, they command a high premium in the market. Dividend gives a fairly regular income. Also, these companies demand decent premium in the stock markets. So, you can look at good capital appreciation as well.
The calculation of dividend yield uses the market price of the stock. A long term investor buys a stock and holds it for a long term. During this time, the stock may undergo stock splits and bonuses. Also, the price of the stock goes up over time. This means that although the prevailing price of the share is high, your cost of acquisition of the stock could be fairly lower compared to the market price. Over a period, the cost per share would come down - for example, because of additional bonus shares issued. This increases the effective yield for investors.
