Financial Dictionary -> Investing -> Dividend

Investing in shares provides two potential sources of financial return. The share price might rise, providing a capital gain which you can sell on the stock market and make a profit on the original purchase. But in addition companies pay something called an annual dividend to shareholders, which is basically a thank you bonus for investing in the business.

The size of a dividend depends upon the level of retained profits made that year (basically spare money that isn't needed elsewhere) and the amount of shares owned by the shareholder. The amount decided is fixed per share. If a company is going through financial problems they do not necessarily have to pay out a dividend. In fact a company never has to pay any out, but if that was the case there would probably be few investors. Companies usually work out a fair percentage that goes out to dividends and what is reinvested into the business to help it expand.

Shareholders use what are known as 'shareholder ratios' to provide a way of judging whether the shares are expensive or inexpensive and whether the dividends being paid out are high enough. This puts pressure on companies to achieve short term profits and to pay out consistently high dividends; however in the long term it may have an adverse affect on the company's finances and then ultimately it is the shareholders that end up worse off.

The dividend yield ratio directly relates to the amount of dividend actually received compared to the market value of the share. It shows the shareholder's annual dividends as a percentage of the total invested. This can be calculated by the following:

Dividend Yield = Ordinary Share Dividend / Market Price Per Share x 100
The higher the result the better.

Dividends are mainly paid in cash, but are sometimes paid in store credit or in the form of more shares.