Dividend yield can be an important gauge of company’s health

A company’s “dividend yield” expresses the relationship of two numbers: a stock’s price and the amount of its annual dividend. It’s a number investors need to understand.

Consider Verizon Communications. It was recently trading around $36 per share, paying out 38.5 cents per quarter ($1.54 per year) as a dividend. Take $1.54 and divide it by $36, and you’ll get 0.043. Multiply that by 100, and you have a dividend yield of 4.3 percent. If you pay $36 for a share of Verizon today, you’ll earn 4.3 percent per year on your investment, just from dividends alone.

Companies rarely decrease or eliminate their dividends, as that would make investors unhappy. (It does happen, though.) Dividends of healthy companies tend to increase over time, delivering additional value to shareholders. If in 20 years Verizon’s dividend is $3, which would represent an 8 percent dividend in relation to those shares you bought for $36. (You paid $36; you receive $3 per year.) You’d be earning 8 percent each year, just from dividends. There would likely be some stock price appreciation on top of that, too.

A dividend will hold steady for months or years at a time. (Verizon has paid $1.54 yearly since 1998.) But the yield usually fluctuates daily, since it’s tied to the stock’s price. As a stock price rises, the yield falls, and vice versa. If Verizon shares, for example, suddenly doubled in price to $72, the yield would be halved, to 2.1 percent ($1.54 divided by $72 is 0.021).

You can find some hefty yields among companies whose stock prices have tumbled – but be careful. If you spot an unusually high dividend, make sure the company isn’t in so much trouble that a dividend cut is around the corner. Companies such as AT&T, General Motors, IBM and Eastman Kodak have cut their dividends when struggling.

Last, understand that not all companies pay dividends. Younger or quickly growing companies prefer to plow their extra cash back into operations. Dell, Starbucks, Amazon.com and eBay don’t pay dividends. Microsoft began paying a dividend only last year.

Find promising dividend payers at www.incomeinvestor.fool.com and http://screener.finance.yahoo.com/newscreener.html.

Ask the Fool

Q: What are “unrealized gains”? – S.F., Bowling Green, Ohio

A: When you sell an investment, you usually realize a gain or loss. If you buy Porcine Aviation (ticker: PGFLY) at $50 per share and then sell it a few years later at $72, you’ll have a realized gain of $22 per share (less commissions).

Meanwhile, perhaps you bought shares of Cheese Sciences Inc. (ticker: CURDS) at $35 per share, and they’re now trading at $45. If you haven’t sold any shares, you have an unrealized gain of $10 per share. This is also called a “paper profit.” It’s your profit in theory only – since you haven’t actually sold the holding, you haven’t actually realized the gain.

Q: How should I evaluate my bank? – F.T., Birmingham, Ala.

A: Here’s one way: Gather all your banking statements and records for the past three months. On a sheet of paper, note how much you’ve been paying for the following expenses: ATM surcharges, “foreign” ATM fees, other ATM fees, overdraft fees, monthly maintenance fees, check printing fees, deposit/other slips, call center charges, debit card fees, low-balance penalties, per-check charges, return check/NSF fees, money order fees, traveler’s check fees and any other bank fees.

Once you’re done, total everything and see how much of your money is going to your bank — compare that with the interest it’s paying you. If you’re not pleased with the results, look into the fees and offerings of other banks. (Or consider changing some of your money management habits.) Do business with the bank that offers the services and conveniences you need with the most reasonable fees. Consider credit unions, too. Learn more about your banking and savings options at www.fool.com/money/banking/banking.htm, www.fool.com/savings and www.cuna.org.

My dumbest investment

My dumbest investment mistake was not buying Wrigley stock back in high school, when I was involved in “The Stock Market Game” and it was trading for about $16 per share. Now it’s around $63! I could kick myself! – W. White, Washington, D.C.

The Fool Responds: You’re not alone in having passed up a good opportunity. But you know more now than you did then – our vision is always better in hindsight. Even super-investor Warren Buffett has these kinds of regrets. He often mentions how he blew it by not buying a lot of Wal-Mart stock years ago, noting that that mistake has cost him several billion dollars.

On another note, young people should be careful with stock market contests often conducted in schools. They’re a great way to learn about how investing works, but their focus on short-term results is dangerous. Over a few weeks or months, great stocks can falter and lousy ones can zoom up. No one can consistently and accurately predict what the stock market will do in the short term. What really counts is how your investments fare in the long run.