Dividend yield is the ratio between the dollar value of the dividend a company pays and its share price. This is represented as a percentage.
Using simple math, you can figure out the dividend yield of stocks. You can even get the yield for your entire portfolio. This can be a useful tool when you are looking at new investments. It can also help you plan for retirement.
But, dividend yields don’t often show the whole picture. They shouldn’t be the only factor when you are investing.
Definition and Examples of Dividend Yield
Since it's a ratio of yearly dividend to stock price, dividend yield simply tells you how much cash flow your investments generate. This is given as a percentage of the value of your holdings.
When a company pays a dividend, it returns a part of its profits to shareholders. This happens on a fixed schedule. Often, payouts are once each quarter. You can take dividends as cash that you can keep. Or, you can reinvest the income by buying new shares.
Dividend yield can change over time. This happens along with changes to how much the company pays in dividends. Changes in stock price also affect yield.
How to Calculate Dividend Yield
On a stock, the formula for dividend yield is the amount of the annual dividend payments divided by the share price of the stock. Then multiply by 100 to turn the result into a percentage.
Let's say that a firm pays a dividend of 25 cents every quarter. Then, the yearly dividend paid out would be 25 cents x 4 quarters = $1.
If the stock is priced at $100 per share, the dividend yield would be:
$1 / $100 = 0.01
0.01 x 100 = 1%
A $50 stock with a $1 per share dividend has a dividend yield of 2%. When the price of that $50 stock drops to $40, the dividend yield changes to 2.5%. If it increases to $60, the dividend yield becomes 1.7%.
When looking at the dividend yield of a whole portfolio, you can toggle your numbers up and down to see what you’re up against. It’s best to run different scenarios with online calculators. Or, you can discuss them with your financial advisor. This is wise if if you’re playing with these numbers as part of your retirement planning.
Why Does Dividend Yield Matter?
Dividend yield matters because it shows you how much income you can expect to earn.
If you’re planning for retirement, it’s best to have an idea of how much money you’ll need. You will also need to know which holdings can get you there.
Let's look at this in two ways.
Let’s say you own 100 shares of a $50 stock with a $1 per share yearly dividend. This means a 2% dividend yield. The value of this holding is $5,000 (100 shares x $50). With a 2% dividend yield, you can expect to get $100 per year in payments (2% of $5,000 = $100).
This doesn’t mean you can simply select any stock that pays a dividend. Not all dividend payers are the same. You must think about other factors. Weigh the risks before making a choice.
Super high dividend yields could signal trouble. Remember, as stock price decreases, dividend yield tends to increase. The company may not be able to keep up with dividends forever.
One way to assess the strength of a dividend is to look at a firm’s payout ratio. Payout ratio is an equation that expresses the percentage of a company’s net income that it pays out to satisfy its dividend.
Ideally, you want the payout ratio to be around 40% to 60%. Anything much higher (or lower) requires a closer look.
One of the most tried and true methods for selecting dividend stocks is loosely related to yield—dividend growth. Simply put, does a firm have a long history of increasing its dividend each year? You can find the best of breed in dividend aristocrats. These are companies with a 25-year or longer history of dividend increases.
Even here, proceed with care. History is filled with strong companies with a solid track record of paying dividends who ran into trouble.
For example, General Electric (GE) had a long dividend-paying legacy before the Great Recession. But in 2009, it was forced to cut its dividend from 31 cents to 10 cents. This cutback in dividend was GE’s first since 1938 and was a sign of tougher times ahead. In 2009, before it slashed its dividend, GE’s dividend yield was 10.6%.
Since then, GE has seen its stock price drop. It has been forced to spin off businesses and cut jobs. It was an original member of the Dow Jones Industrial Average in 1896, and a constant part of the index since 1907. But, GE lost its place in the Dow in 2018. In 2019, the company slashed its quarterly dividend payout down to 1 cent. Its share price was $11.08 in December 2019. This means its dividend yield was about 0.3%—much lower than what it was 10 years earlier.
Your Overall Portfolio
Do you hope to live off of the income from your entire dividend stock portfolio? If so, you need to know two basic things.
First, figure out how much money you require to live. Let’s say it’s $40,000 a year. From here, the second factor comes in. How large of a nest egg will you require related to the dividend yield of your holdings?
For example, let's say that you have $500,000 invested. In this case, your portfolio will need to yield 8% to throw off $40,000 in yearly income. It's not impossible. But, it’s a rather lofty goal. A $1,000,000 portfolio that earns $40,000 a year in income has a dividend yield of 4%.
Dividend Yield on Market vs. Dividend Yield on Cost
Know the difference between dividend yield on market and dividend yield on cost. It can help you analyze the performance of your dividend stock portfolio. These terms can sound daunting, but they’re really not.
Dividend yield on market is simply the dividend yield based on a stock’s current share price.
To get the dividend yield on cost, look at what you paid for the stock when you added it to your portfolio. Take the stock’s yearly dividend. Divide it by the original share price rather than the current share price.
|Dividend Yield on Market||Dividend Yield on Cost|
|Based on the stock’s current share price||Based on the stock’s share price at the time you added it to your portfolio|
Let's say that the stock’s yearly dividend payout is $4 and the current share price is $100. The dividend yield on market is 4%. If the same stock cost $90 when you added it to your portfolio, the dividend yield on cost is 4.4%.
By figuring out dividend yield on cost, you do two things. You factor in a company’s dividend growth without punishing it for stock price appreciation.
As a company’s stock price increases, its dividend yield decreases. Yield on cost accounts for this. You’re using your original cost basis in the calculation. You're also looking at dividend growth. This can offset a decrease in yield related to an increase in a company’s stock price.
The Bottom Line
Many factors affect investment strategies. It’s best to consult a financial advisor to figure out your needs. But, dividend yield can help you understand the income you can expect to receive now and into the future.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.