Dividends: why a high percentage is not always good news
In short
- A dividend is a share of profit that a company pays out to shareholders.
- The dividend yield is the dividend divided by the price.
- A very high percentage can come from a price that has fallen, and so be a warning.
Some companies hand out part of their profit to their shareholders. That is called a dividend. It is usually paid once or a few times a year.
The dividend yield
The dividend yield is the annual dividend divided by the current price. If a share pays 2 euros of dividend a year and costs 40 euros, the yield is 5 percent.
Why a high percentage can mislead
The percentage depends on the price. If the price falls sharply, the percentage rises, without the company paying more. A yield of 12 percent can therefore mean that the market expects the dividend to be cut.
A company can also pay out more than it earns. That works for a while, but not forever. So look at the payout ratio: the part of profit that is paid out. If it is close to or above 100 percent, the dividend is vulnerable.
A dividend is not a gift
After the payout the price usually drops by roughly the dividend. You then hold less share and more cash. The total value does not change because of the payout itself. Tax may also be due on the dividend.
What you can ask
Is the dividend covered by profit? Has the company always paid it, also in bad years? This is an explanation of how dividends work. It is not advice to buy a particular share.
