Do you want to learn how to calculate dividends like a pro? This article will walk you through seven examples of dividends calculations so you can gain a better grasp of how to determine your returns. Whether you’re a seasoned investor or just starting out, this guide will help you understand how to figure dividends in different ways. So take a piece of paper and a calculator, and try these methods to see what works better for you.
1. The Dividend Yield Formula
This is a simple way to calculate the percentage return on your investment. Just divide the annual dividend per share by the current stock price and multiply by 100. For instance, a stock with an annual dividend of $2 and the worth of $100 per share would bring the dividend yield of 2%.
2. The Dividend Payout Ratio
This is a financial metric that displays the percentage of a business’ profits paid out to shareholders in the form of dividends. It is figured by dividing the overall amount of dividends paid out by the business during a given period (usually a year) by its net income for the same period. The resulting ratio represents the portion of a company’s earnings that is distributed to shareholders rather than being retained for reinvestment in the business.
For instance, if a business has a net income of $1 million and pays out $200,000 in dividends during a year, the payout ratio would be 20% ($200,000 divided by $1,000,000). This means that the company is paying out 20% of its profits to shareholders and reinvests the remaining 80% in business.
3. The Dividend Discount Model
This is a more complex way to calculate dividends. It relies on the current stock price, expected dividend growth rate, and required rate of return. This formula is widely used by investors who are looking to project future dividend payments. However, it requires in-depth research and analysis.
4. The Gordon Growth Model
This approach assumes that dividends will grow at a constant rate. To use the Gordon Growth Model, you first need to determine the current dividend payment for the stock you are interested in. Let’s say the current dividend per share is $2.
Next, you need to estimate the expected dividend growth rate. This can be based on historical growth rates, industry trends, or other factors. For example, you can expect the dividend growth rate to reach 5%.
Finally, you need to determine the required rate of return for the stock. This is the rate of return that investors require in order to invest in the stock. It takes into account factors such as the riskiness of the stock and the overall market conditions.
Let’s say you expect the required rate of return to be 10%. With these pieces of information, you can then use the Gordon Growth Model formula to calculate the intrinsic value of the stock. The formula is:
Intrinsic Value = D / (r – g)
Where:
D = expected dividend payment
r = required rate of return
g = expected dividend growth rate
Using the values we calculate that:
Intrinsic Value = $2 / (0.10 – 0.05)
Intrinsic Value = $40
5. The Ex-Dividend Date
The ex-dividend date is the time when a stock ceases to be profitable and generate dividends. In other words, if you buy a stock on or after the ex-dividend date, you won’t get any payments. By knowing the ex-dividend date, you can calculate the amount of the next dividend earnings and plan your investments accordingly.
6. The Total Return Formula
The total return formula includes both capital gains and dividends. To calculate the total return, add the change in stock price to the dividend yield, and divide by the original stock price. For instance, if a stock is worth $50 per share, pays a $2 dividend, and rises to $60 per share, the total return would be 24%.
7. Dividend Reinvestment
This strategy involves using dividends to purchase additional shares or stocks. By reinvesting dividends, you can compound your returns over time and potentially earn more money in the long run.
Let’s say you own 100 shares of a stock that pays an annual dividend of $2 per share, and the stock is currently trading at $100 per share. That means you will receive a total of $200 in dividends each year ($2 x 100 shares).
Instead of taking dividends, you decide to reinvest them and use the money to purchase additional shares of the same stock. Let’s say the stock has an average annual return of 8%.
After the first year, you will have earned $200 in dividends. Instead of taking the cash, you use that money to purchase two more shares at the current price of $100 per unit. So at the end of the first year, you now own 102 shares of the stock. Your total dividend payment for the year was $200, but because you reinvested the dividends, you now own more shares of the stock.
Wrapping up
Calculating dividends is a complex process, but it’s an integral part of investing because it allows you to estimate and predict your earnings. By using the above-mentioned seven approaches, you can get more insights on how dividends work and make informed decisions about your investments. Always keep in mind that investing is risky, so be sure to consult with a financial advisor before making any investments.
