Dividend Rate Vs Dividend Yield: Understand the Differences

It is no hidden secret that the stock market is a great place to build a corpus. Conservative, prudent investments can help you create wealth gradually. Many people invest in this market, not only to create a corpus but also to ensure that they can have a steady source of income. An excellent way to ensure that you can create a regular and steady income stream is to invest in companies offering dividends. However, most people are confused about the difference between dividend rate and dividend yield. Read on to find out the difference between the two terms.

Dividend rate vs dividend yield – the differences

The best way to understand the difference between dividend rate and yield is to start with their definitions. They are as under:

Dividend rate: Dividend rate, often plainly referred to as dividend, is essentially the total expected dividend payment that you can get form a specific investment, which could be a stock, a mutual fund or another such money market instrument. Dividends are typically paid either quarterly or on an annual basis. The dividend rate could be fixed or adjustable, and it generally depends on the preferences and strategies followed by the company offering the dividend. The board of directors of the company offering this bonus determines the dividend rate, which is then approved by shareholders.

Dividend yield: Dividend yield is simply the financial ratio that demonstrates how much a particular company is paying in dividends, each year about its stock price. The dividend yield is generally expressed in percentage and represents an estimation of the dividend-specific return of an investment. As mentioned above the dividend rate can either remain the same as the previous financial year, or it could increase or decrease. In case the dividend amount remains unchanged, the yield will rise when the stock price falls. Conversely, the yield will fall in case the stock price rises. Since the dividend yield changes with the stock price, it may often appear unusually high, especially for those stocks, which are falling quickly.

Example to help understand the difference between dividend rate and dividend yield

Let’s say you invest Rs.100,000 in XYZ Bank, for which you are allotted 1000 share units. Now, the bank declares dividends of Rs.5 per share, which is the dividend rate. In such a situation, you will receive a total dividend amount of Rs.5,000. In this situation, your dividend yield can be calculated as below:

Rs.5,000 x 100/100000 = 5 per cent

Book closure and ex-dividend aspects of dividend rate vs yield

While the formula mentioned above applies to investments held for an entire financial year, you have to consider the yield ratio for shorter investments, based on the stock’s book closure. For instance, if XYZ Bank’s book closure is on 1^st July, and you purchased your shares on 1^st January, you would be eligible for a 10% yield, since the shareholding period is only six months, as opposed to a year.

Apart from the book closure, it would help if you also considered the ex-dividend aspect, which is the date after which you will not be eligible to receive dividends in a given financial year. Thus, if XYZ Bank announces 25^th July as book closure, the stock exchange may declare 20^th July as the ex-dividend date, after which you will stop receiving dividends from the company.

Factors Impacting Dividend Rate

Some companies announce dividends regularly, and these stocks can be an investor’s favourite. If you wish to invest in dividend stocks, it is important to understand the factors responsible for framing the dividend policy of a company.

Profitability and cash flow: To pay regular dividends, the company must generate continuous profit and maintain a healthy cash flow. The amount of profit the company earns also influences the dividend amount. Higher profitability and ample cash flow will ensure the company can distribute dividends to its shareholders.

Growth plan and investment needs: Companies that need significant investment to maintain growth momentum may choose to retain earnings instead of distributing dividends. When companies reinvest profits into expanding operations and research, they aim to drive future growth and enhance shareholders' value. 

Financial stability: When a company is financially stable, it can adopt a sustainable dividend policy. Factors such as low debt levels, high liquidity, and steady earnings growth instil confidence in investors and support sustainable dividend payments.

Dividend payment history: A company with a history of dividend payments will maintain a steady dividend rate for its future dividend payments because it satisfies shareholders and increases the company's reputation.

Factors Impacting The Yield

Dividend yield tells investors how much the company is paying as a dividend compared to the current market value per share. A company's dividend yield policy is shaped by factors such as earnings, payout ratio, market conditions, capital structure, and growth prospects. By understanding these factors, investors can evaluate dividend-paying stocks more efficiently.

Dividend policy: A consistent and stable dividend policy will result in a higher dividend yield. The dividend policy is a strategic decision made by the company’s management, considering various internal and external factors.

Payout ratio: A payout ratio refers to the portion of net income the company pays out in dividends. A higher payout ratio implies a larger portion of earnings being paid out as dividends and less being retained for reinvestment and growth. 

Financial performance: A company's dividend yield policy is closely related to its earnings and cash flow. Higher profitability and cash flow allow for larger dividend yields.

Capital structure and debt level: A company's capital structure and debt level affect its financial flexibility. A company with a higher debt level may face constraints in distributing dividends due to its debt obligations.  

Rate of interest: The rate of interest in the economy impacts the dividend yield ratio. In situations like lower interest rates, investors look for alternative sources to earn higher returns. This increases the demand for dividend stocks but reduces the dividend yield per share.

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