Let us take an example where a company sells $10 million worth of goods. After taking off costs and charges of, say, $6 million, it has $4 million left. This $4 million is its gross or pre-tax profit on which it has to pay corporate tax of 40 per cent or $1.6 million, leaving a net profit of $2.4 million.

Normally, the company will decide to retain a portion of its profits to plough back into the business and distribute a part of it as dividends to shareholders. Let us assume it decides to keep half of its profits and pay half of it to shareholders.

If the company had an issued capital of 10 million $1 shares, then its earnings per share (EPS) is 24 cents ($2.4 million divided by 10 million) and its dividend will be 12 cents per share.

As Singapore and Malaysian companies pay their dividends to shareholders net of tax, shareholders will receive the 12 cents per share. However, companies usually gross-up their dividends, that is, include the corporate tax, when they announce them. The 12 cents, dividend in our example will be reported as a gross dividend of 20 cents per $1 share, or 20 per cent, if corporate tax is at 40 per cent.

Dividend Yield

Next, look at the relationship between dividends and market price. Using the same example, the gross dividend yield before tax is taken off is 3.33 per cent (20 cents divided by $6 multiplied by 100). This will enable you to compare the dividend yield of shares with, say, the returns on fixed deposits which are paid to you before tax is taken off. Remember, you must compare like with like.

Say you have $1,000 to invest. You could either put this in a one year bank fixed deposit paying interest of 5 per cent, or you could buy 1,000 PQR shares of $1 par value which are also paying a dividend of 5 per cent. On the face of it, both investments will give you a return of $50 on your $1,000.

The situation changes, however, when you have to pay a different amount for PQR shares. If the market value of PQR shares is 70 cents, you will have to pay only $700 for 1,000 shares but you will still get a return of $50. This means that your dividend yield is 7.14 per cent (50 divided by 700 multiplied by 100).

You will find that as market price falls, the yield will rise and vice versa. You can't have both.

Calculating Dividend Yield

What happens if the par value of PQR shares is 50 cents? If PQR is still paying a dividend of 5 per cent and the market value of the share is 70 cents, then we arrive at the dividend yield by this general formula:

Dividend Yield = (Dividend % x Par Value) / Market Price x 100

'Dividend %' is expressed as a fraction. Hence our dividend yield in the above example is 3.57 per cent:

Dividend Yield = (5/100 x 0.50) / 0.70 x 100 = 3.57%