# Fundamental Analysis: Understanding Dividend Yields and Payout Ratio

Accountancy Resources

Author: Admin

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Don’t Let Dividends Intimidate You. They Are Not as Complex as You Might Think.

Part of being a successful stock market investor is knowing what type of analysis fits your personality. If you like to trade in and out of fast-moving stocks, then you should be using only technical analysis.  If you are a long-term investor, then fundamental analysis is what you need.

But even with long-term investors, there are subcategories.  If you are looking for dividend income with your stocks then you should know how to calculate certain dividend metrics and understand how they play into your analysis.

## Dividend Yield

Warren Buffett holds up to 40 different stock positions in his Berkshire Hathaway holding company and everyone knows he loves to invest in dividend stocks.

Dividend Yield tells you what percentage return a company pays out to shareholders in dividends and can be calculated as so;

Annual Dividend per Share / Stock Price per Share = Dividend Yield

For example, if a company’s dividend is \$3.00 and their stock trades at \$50.00, then the Dividend Yield is 6%, or \$3.00 / \$50.00 = 0.06.

It is important to remember when using this metric that hot, young companies — especially in the tech sector — will rarely pay dividends as opposed to larger, more mature companies in traditional industries.

The dividend yield is a way to show how much return investors are getting for each dollar invested in a stock.  Investors seeking to get a minimum amount of return by investing in dividend-paying stocks can use this metric to screen potential candidates.

## Dividend Payout Ratio

A lesser-known metric to investors is the Dividend Payout Ratio.  This can be calculated in two different ways;

Yearly Dividend per Share / Earning per Share

or…

Dividends / Net Income

The payout ratio gives an investor an idea of how well dividend payments can be supported by current earnings.  As a general rule of thumb, a stable dividend payout ratio indicates that a company’s dividend policy is consistent and well thought out by the board of directors.

As always, with any form of fundamental analysis, the conclusions are open to interpretation.

If you are an investor seeking to construct a portfolio of dividend-paying stocks, even the best analysis can be rendered worthless by unexpected movements in the underlying issues.

If you invest \$10K into a \$50.00 per share stock, paying a 5% dividend, you would roughly receive \$500 annually in income.  But what if that stock were to drop in price just by 10%?  You would effectively lose 2x your yearly dividend income in principal.

This is why it is important to diversify your holdings among different strategies and types of analysis so you can avoid putting all your eggs in one “yield” type basket.

See the following topics for more on fundamental analysis;

• Earnings per Share – EPS
• Price to Earnings Ratio – P/E
• Price to Sales – P/S
• Price/Earnings to Growth – PEG
• Price to Book – P/B
• Book Value
• Return on Equity

As my series on fundamental analysis continues we will cover all those topics so you can get a well-rounded understanding of the process for picking winning stocks.

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