Companies that are listed on a stock exchange, such as the Australian Securities Exchange (ASX), offer part ownership to investors in the form of shares, also known as equities or stocks. An investor who purchases shares in a company becomes a shareholder. While the primary goal of stock investment is to grow wealth, a shareholder may also be entitled to vote on decisions made by the company that could influence its future performance and value.
Typically a company will split itself into a fixed number of shares, anywhere from $10000$10000 to $10$10 million or more. They then decide how many to make outstanding shares, the shares that can be freely traded between investors through the exchange, and how many to keep within the company. The total value of the company being traded on the market is called its market capitalisation, and each share represents an equally small portion of this value.
$\text{Share price }=\frac{\text{Market capitalisation }}{\text{Total outstanding shares }}$Share price =Market capitalisation Total outstanding shares
The actual buying and selling of shares on the stock market is performed by licensed stock brokers on behalf of investors. Brokers will charge a brokerage fee for this service, which can be either a fixed amount or a percentage of the value of the shares traded.
Dividends
The market capitalisation of a company will change over time, so ideally an investor will look to purchase shares in a company that has consistent growth. In this way the value of their shares will also increase. So far this sounds similar to the other forms of investment we have covered previously.
If a company makes a profit, it may also decide to share some or all of this profit with its shareholders in the form of a dividend. Dividends are usually paid semi-annually, and are divided equally among the total outstanding shares.
$\text{Dividend per share }=\frac{\text{Portion of company profit }}{\text{Total outstanding shares }}$Dividend per share =Portion of company profit Total outstanding shares
The portion of the profit that the company passes on to the shareholders can be anywhere from $0%$0% to $100%$100% of its total profit.
Exploration
The market capitalisation of the Widget & Trinket Corporation (WTC) is distributed equally among $500000$500000 shares. This year the WTC recorded a profit of $\$1622034$$1622034.
The WTC paid $30%$30% of its profits in tax and passed the rest on to its shareholders as dividends.
Let's use this information to calculate the dividend per share.
We can first find the after-tax profit, then divide this amount by the total number of shares in the company.
| $\text{Dividend per share }$Dividend per share | $=$= | $\frac{\text{Portion of company profit }}{\text{Total shares in company }}$Portion of company profit Total shares in company | |
| $=$= | $\frac{\left(100%-30%\right)\times1622034}{500000}$(100%−30%)×1622034500000 | (Subtract $30%$30% that was paid in tax) | |
| $=$= | $\frac{\left(1-0.3\right)\times1622034}{500000}$(1−0.3)×1622034500000 | (Convert percentages to decimals) | |
| $=$= | $\frac{0.7\times1622034}{500000}$0.7×1622034500000 | ||
| $=$= | $\frac{1135423.8}{500000}$1135423.8500000 | ||
| $=$= | $2.27$2.27 (2 d.p.) |
The WTC paid a dividend of $\$2.27$$2.27 per share.
Now consider if we had $5000$5000 WTC shares, how much would we earn as a dividend payment?
We earn $\$2.27$$2.27 per share, so multiply the number of shares by the dividend amount.
$5000\times2.27=11350$5000×2.27=11350
So we would earned a dividend payment of $\$11350$$11350 for the year.
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 and represents the dividend as a proportion of the share price. The greater this percentage, the more lucrative the investment.
$\text{Dividend yield }=\frac{\text{Dividend per share }}{\text{Price of share }}\times100%$Dividend yield =Dividend per share Price of share ×100%
Exploration
The share price for Bank of Australia (BOA) is $\$48.90$$48.90 and profits for the year have generated dividends of $\$3.68$$3.68 per share.
The share price for New Zealand Bank (NZB) is $\$4.35$$4.35 and the profits for the year have generated dividends of $\$0.78$$0.78 per share.
What is the dividend yield for each share this year?
We will use the dividend yield formula using the share price and the dividend price.
| $\text{Dividend yield for BOA}$Dividend yield for BOA | $=$= | $\frac{\text{Dividend per share }}{\text{Price of share }}\times100%$Dividend per share Price of share ×100% |
| $=$= | $\frac{3.68}{48.90}\times100%$3.6848.90×100% | |
| $=$= | $0.0752556\ldots\times100%$0.0752556…×100% | |
| $=$= | $7.53%$7.53% (2 d.p.) |
The dividend yield for BOA is $7.53%$7.53%.
| $\text{Dividend yield for NZB}$Dividend yield for NZB | $=$= | $\frac{\text{Dividend per share }}{\text{Price of share }}\times100%$Dividend per share Price of share ×100% |
| $=$= | $\frac{0.78}{4.35}\times100%$0.784.35×100% | |
| $=$= | $0.1793103\ldots\times100%$0.1793103…×100% | |
| $=$= | $17.93%$17.93% (2 d.p.) |
The dividend yield for NZB is $17.93%$17.93%.
Even though the NZB shares generated less dividend per share, it had a higher dividend yield. Anyone who invested $\$1000$$1000 in NZB shares at the beginning of the year would receive $\$179.30$$179.30 at the end of the year as a dividend, which is more than twice as much money as they would have received as a dividend if they invested in BOA shares instead.
Share - A small portion of a company, representing part ownership for its owner.
Outstanding share - A share traded freely on the stock market.
Shareholder - The owner of a share or shares.
Market capitalisation - The value of the part of the company represented by its outstanding shares.
Brokerage fee - The fee that stock brokers charge for their services. Can be a fixed amount, or a percentage of the value of the transaction.
Dividend - A payment made to shareholders, usually annually or semi-annually, proportional to the number of shares they hold, and the profit made by the company.
Dividend yield - The percentage of the share price that is paid as a dividend.
Practice questions
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
Shares in Bank of Australia are worth $\$2.65$$2.65. If an annual net profit of $\$1500000$$1500000 is to be distributed across $12000000$12000000 shares:
What is the dividend per share, correct to the nearest cent?
Using the answer to part (a), what is the total dividend received on $2000$2000 shares, correct to the nearest dollar?
Using the answer to part (a), find the dividend yield as a percentage, correct to two decimal places.
QUESTION 3
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%.