Every Fool loves dividends. What better way to juice your stocks' returns than by enjoying regular cash payments from your companies? Best of all, dividends can tell you a lot about a company -- provided you know what to look for.
A dividend is a portion of a company's earnings that it pays out to its shareholders. If Home Surgery Kits (Ticker: OUCHH) is earning roughly $4 in profit per share each year, it might decide that it will issue $1 per share annually to shareholders. If so, it will probably pay out $0.25 per share every three months.
This may seem like a pittance, but it adds up. If you own 500 shares of a company that's paying $1 per share in dividends, you'll receive $500 per year from the company.
If you're evaluating a company's dividend, make sure you're looking at its dividend yield -- the current annual dividend, divided by the current share price. Suppose two companies are each paying $2.50 per share in dividends, but one company is trading at $25 per share, and the other at $50 per share. The first company has the greater yield; it pays you back 10% of your initial investment in cash, compared to the second company, which yields only 5%.
Remember that since the dividend yield is essentially a fraction, with the annual dividend on top and the share price on the bottom, it will fluctuate daily along with the share price. (Annual dividend amounts will change only every year or so.)
Be a dividend detective
If you look closely, dividends can tell you a lot about a company's fortunes:
- Most dividend-paying companies are in fairly stable financial shape, since they need to be fairly certain they'll have enough cash on hand to keep making those payments to shareholders. Better still, companies with track records of regularly and significantly hiking their dividends tend to be extra-consistent earners. Paychex
(NASDAQ:PAYX)and Nokia (NYSE:NOK), for example, have hiked their dividends by a compound annual average of 22% and 17%, respectively, over the past five years.
- Though companies usually strive to avoid reducing or eliminating dividends at all costs, the contracting economy has recently forced several businesses to cut or scrap their payouts to conserve cash. Pfizer
(NYSE:PFE), Citigroup (NYSE:C), and Dow Chemical (NYSE:DOW)are just a few of the recent offenders in this category.
- A fat yield alone is no reason to buy a stock. As a stock price rises, the yield will fall, and vice versa. Sure, a hefty dividend yield could reflect a generous company -- but it could also signal that a struggling business's stock has just tanked. Wells Fargo
(NYSE:WFC), for example, sports a recent yield around 8.6%. However, it's currently paying a dividend of $1.36 per share -- even though in the past 12 months, it's earned only $0.75 a share. Wells Fargo obviously can't keep paying out far more than it's actually making for long.
- Dividends generally signal that a company's flush with cash it doesn't immediately need. That cash could otherwise go toward hiring more employees, building or refitting factories, paying down debt, buying back shares, or snapping up a rival, among other uses. That's why younger, faster-growing companies such as Intuitive Surgical
(NASDAQ:ISRG)often pay little or no dividend; they need that cash to help their business expand.
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This article was originally published on Jan. 26, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Pfizer and Paychex are Motley Fool Income Investor recommendations. Pfizer, Paychex, and Nokia are Motley Fool Inside Value recommendations. Intuitive Surgical is a Motley Fool Rule Breakers selection. The Fool owns shares of Pfizer. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool is Fools writing for Fools.