A popular method of investment is through buying shares.
If you are a shareholder in a company, this means you have bought some shares available on the Stock Exchange and you now own a small portion of the company.
How is buying shares an investment?
- When you buy share it's like anything else, you are trying to buy them at a bargain price. You do so with the expectation that over time the value of the company (and thus the value of each share) will increase, meaning your small piece of the company is now worth more.
- Many companies share their annual profits amongst their shareholders by paying them dividends. So each year, if the company you have shares in made a profit, you get paid a portion of that profit.
Buying and Selling Shares
If you are interested in investing in a company through buying shares, you would take a look at the shares available on the Australian Stock Exchange (ASX).
You'd find this information in your newspaper or online, and the buy and sell prices for all stock is updated each day.
You'd then either purchase your shares through a Stock Broker or through your own special stock investment account through your bank. To buy shares you must also pay a brokerage fee.
A stock broker or bank usually charge you a brokerage fee that is some percentage of the total value of the shares you purchased or sold.
Let's say you buy $\$10000$$10000 worth of shares and the brokerage fee is $5%$5%.
You'd need to pay a fee of $10000\times0.05=\$500$10000×0.05=$500
Dividends
Once you have purchased shares in a company, you are now a shareholder.
If that company makes a profit, they will likely share their profit amongst their shareholders by paying them what is called a dividend.
Example 1:
In 2015, the Commonwealth Bank of Australia (CBA) paid its shareholders a dividend of $\$2.22$$2.22 per share.
Thomas has $5000$5000 CBA shares.
How much did Thomas earn as a dividend payment?
Think: Thomas earns $\$2.22$$2.22 per share, so we multiply the number of shares he owns by the dividend amount.
Do: $5000\times2.22=\$11100$5000×2.22=$11100
Dividend Yield
One way to compare the value of investing in one company versus another company is to calculate and compare the dividend yield.
The dividend yield is expressed as a percentage represents what proportion of the share price is paid as a dividend to shareholders. The greater this percentage, the more lucrative the investment.
Dividend Yield = $\frac{\text{dividend per share }}{\text{market price of share }}\times100$dividend per share market price of share ×100
Example 2:
In mid January, 2016, the share price for Rio Tinto was $\$38.90$$38.90 and the dividend yield was $9.46%$9.46%.
What is the expected dividend per share?
Think: We will use the dividend yield formula to calculate the dividend per share.
Do:
| $9.46$9.46 | $=$= | $\frac{\text{dividend }}{38.90}\times100$dividend 38.90×100 |
| $0.0946$0.0946 | $=$= | $\frac{\text{dividend }}{38.90}$dividend 38.90 |
| $0.0946\times38.90$0.0946×38.90 | $=$= | dividend |
| dividend | $=$= | $\$3.68$$3.68 |
Price to Earnings Ratio
Another way to compare the value of different shares is through the price to earnings ratio.
P/E=$\frac{\text{Market price per share }}{\text{Annual earnings per share }}$Market price per share Annual earnings per share
Once calculated, the P/E tells us how many years of dividends at this value would need to be paid to us to earn back what we spent buying the shares in the first place.
So if the P/E = $4$4, this means it would take four years of dividends for us to break even on the purchase of those shares.
Example 3:
Janet bought shares with a dividend yield of $5$5%.
The company returns $40$40% of its profits to the shareholders.
She paid $\$3440$$3440 for $200$200 shares.
(a) Calculate the market price of the shares
| Market Price | $=$= | $\frac{3440}{200}$3440200 |
| $=$= | $\$17.20$$17.20 | |
(b) Calculate the dividend per share
| $0.05$0.05 | $=$= | $\frac{\text{dividend }}{17.20}$dividend 17.20 |
| dividend | $=$= | $0.05\times17.20$0.05×17.20 |
| $=$= | $\$0.86$$0.86 | |
(c) Calculate the annual earnings per share
| 40% of Annual earnings | $=$= | $0.86$0.86 |
| Annual earnings | $=$= | $\frac{0.86}{0.4}$0.860.4 |
| $=$= | $\$2.15$$2.15 | |
(d) Calculate the P/E
| P/E | $=$= | $\frac{17.20}{2.15}$17.202.15 |
| $=$= | $8$8 | |
More Worked Examples
QUESTION 1
Sally bought $800$800 shares in Global Minerals Co. at $\$2.35$$2.35 each.
Calculate the value of the shares Sally bought.
The stockbroker charges a fee of $\$15$$15 to buy or sell stocks up to a value of $\$10000$$10000 and $\$25$$25 for transactions over $\$10000$$10000. How much does Sally pay in fees?
$\$15$$15
A$\$25$$25
BAfter a period of time, Sally receives a dividend of $\$0.26$$0.26 per share. What is Sally’s gross dividend, correct to the nearest dollar?
Calculate the dividend yield. Leave your answer as a percentage correct to two decimal places.
QUESTION 2
Calculate the total dividends that will be paid out to someone that buys $1200$1200 shares at $\$23.40$$23.40 per share and the dividend yield is $\frac{37}{10}%$3710%.