A dividend is the share of profit a company pays out in cash to its shareholders. It's one of the two ways to make money on a stock: the periodic dividend payment and the rise in the share price.
What a dividend actually is
When a company makes money, it can do two things with it: reinvest it in the business (grow, reduce debt, buy back shares) or pay it out to its owners. That cash payout is the dividend. It's usually paid periodically (quarterly or annually) and expressed as an amount per share: for example, $0.50 per share each quarter.
The dividend yield
To compare the dividend across companies of different prices you use the dividend yield: the annual dividend divided by the share price.
- Dividend yield = Annual dividend per share ÷ Share price × 100
If a stock costs $100 and pays $4 a year, its dividend yield is 4%. It's what you collect in cash each year per dollar invested, regardless of whether the price rises or falls.
Beware of yields that are too high
A very high dividend yield is tempting, but it's often a trap. The formula has price in the denominator: if the price collapses because the business is struggling, the yield spikes… right before the company cuts the dividend it can no longer afford. A 12% yield is rarely a gift; it's usually a warning.
Is that dividend sustainable?
The key question isn't how much it pays, but whether it can keep paying it. For that you look at what share of profit goes to the dividend (the payout ratio) and, above all, whether free cash flow covers the payment. A dividend paid with real cash and a moderate payout is far more reliable than one that forces the company to borrow.
How to use it well
The dividend is just one piece of total return. A company that pays no dividend but grows and compounds value can be a better investment than one with a high but stagnant dividend. Look at the quality of the business (ROE, margins, debt) before the dividend yield in isolation. To see any company's financial health, type its ticker into the analyzer.