Dividends can also have a significant impact on market sentiment. While earnings can be dependent on accounting estimates, dividends represent a payment of actual cash to shareholders. Dividends have become an important component of shareholders' income and return expectations.
Because some shareholders rely on dividends for income, companies that cut their dividends tend to see their shares punished severely by the marketplace, and those that eliminate them entirely tend to lose institutional shareholders who are restricted by policies that dicatate they can only own dividend-paying shares. Because of this, companies tend to only raise dividends to levels that they feel confident they can maintain over the longer term.
This suggests that changes to dividends can give a strong indication of management's expectations of future results. A dividend increase is indicative of confidence, while a dividend cut generally indicates that a company has encountered major difficulties.
- The dividend yield is calculated as: dividend per share / price per share
- The higher the yield, the higher the current return on your capital from dividends.
Sometimes, a high dividend yield can indicate undervaluation, but sometimes it may indicate concerns that the dividend rate may be cut.
To measure the riskiness of the current dividend level, investors can look at the dividend coverage ratio:
Dividend coverage ratio = earnings per share / dividends per share
This measures the company's ability to earn its current dividend. The higher the level, the stronger the potential for dividends to remain at their current level or increase, while a level below 1 suggests the potential for a cut.
Another thing for share traders to consider is that once a dividend is declared, there is a cut-off date by which you must own the shares to receive the dividend. On the first day of trading where a buyer would not get the dividend, known as the ex-dividend date, the price tends to get marked down at the open by the amount of the dividend.
To measure the riskiness of the current dividend level, investors can look at the dividend coverage ratio:
Dividend coverage ratio = earnings per share / dividends per share
This measures the company's ability to earn its current dividend. The higher the level, the stronger the potential for dividends to remain at their current level or increase, while a level below 1 suggests the potential for a cut.
Another thing for share traders to consider is that once a dividend is declared, there is a cut-off date by which you must own the shares to receive the dividend. On the first day of trading where a buyer would not get the dividend, known as the ex-dividend date, the price tends to get marked down at the open by the amount of the dividend.