Dividend Yield (DY) is an important yardstick for dividend investors. Although there are many financial ratios which are important as well. We will focus on DY for this sharing.
How should we interpret DY in our effort to create passive income from dividends?
Dividend Yield= Dividend per Share (DPS)
Share Price
Companies declare DPS in two ways, either cents per share or percentage per share. Do refer to the examples below for reference. We will exclude the transaction cost for simplicity purposes.
1) Cents per Share: If company A declares 5 cents per share, it will translate into 5% DY if market price is assumed to be at RM1 per share. So if you buy 1k shares of company A at RM1 per share, your capital invested will be RM1k, the 1k shares will entitle you to RM50 dividends, in line with 5% DY.
2) Percentage per Share: If company A declares 5% per share, you need to multiply the percentage declared against par value of the share in order to derive the DPS. If par value is RM1 per share, DPS will translate into 5 cents ( 5% multiply RM1 par value). Do find out the company's par value from its financial statement if the company adopts this method,
Dividend declared and paid are known as single-tier dividend, reflecting the fact the the company that you invested in has paid the income tax on the dividend on your behalf, hence the dividend that you receive is already net of tax.
For aspiring investors who are about to begin their investment journeys, perhaps you might want to explore dividend investing first as companies that are paying stable dividends are likely to be financially stronger and operating in a matured industry. Hence, translating into lower investment risk and higher probability of earning positive return provided that you do not pay excessive price for the company shares.
Once you start to earn positive returns from your equity investments, you will feel more confident and you could eventually asset allocate part of your capital into growth stocks as part of your learning & investment journey.
Think of the process of constructing a building for a moment, the foundation is always the most crucial part of the building. Similarly, you could build the foundation of your equity investments portfolio by investing into dividend paying companies.
If you invest into 5 good quality companies that are paying consistent dividends to you, you would have successfully created 5 money printing machines that are generating extra cashflow to you. You could reinvest the cashflow earned into the same companies to earn more dividends, and eventually grow your financial buffer and strengthen your financial position. The additional cashflow could also alleviate any cashflow pressure that you may face due to rising cost of living!
So, do ask ourselves, have we built the foundation of our equity portfolio well?
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