How To Calculate Dividend Yield

The Dividend Yield Formula Calculation Made Easy

Dividend Yield Formula
The dividend yield formula is easy to calculate and can help you compare the cash return on owning a stock to bonds, real estate, and other asset classes.. Shaun Egan / Photodisc / Getty Images

The best way for new investors to compare the immediate return on cash they will enjoy owning a stock to that which they would collect if they, instead, choose to invest in a bond, certificate of deposit, money market account, money market mutual fund, or real estate project, is to calculate something known as the dividend yield.  The process of calculating dividend yield is fairly straightforward, but there are a few tips and tricks I'll pass along that can help you make better sense of why dividend yield matters and how it should compare to alternative sources of passive income.

The Definition of Dividend Yield

When a company generates a profit, the board of directors often decides to mail out some of those earnings to the owners.  For example, writing this on January 28th, 2014, over the past 12 months, each share of McDonald's Corporation has generated $5.55 in after-tax profit, and the board decided to mail $3.24 per share out to the stockholders in cash.  If you owned 100 shares, you received checks or direct deposits for $324.  If you owned 100,000 shares, you received checks or direct deposits for $324,000.

The money that is mailed to the owners is called a dividend.  The dividend yield is a financial calculation that tells you how much money you will earn for every dollar invested in the stock at today's price based on today's dividend rate.  (An alternative interesting concept is something known as dividend yield on cost, which we will talk about later.)

How to Calculate Dividend Yield

To calculate the most common form of dividend yield, you take the per share cash dividend - keeping with our McDonald's example, it would be $3.24 - and divide it into the market price of the stock.

 When this went to digital press, shares of the cheeseburger empire closed at $94.07.  Thus, to calculate the dividend yield we would take:

$3.24 cash dividend
--------- (divided by) ---------
$94.07 stock price

The answer is 0.0344, or 3.44%.  This tells you that if you put $10,000 into McDonald's shares, you'd expect to collect $344 in dividends per year at the current rate.

 If you put $1,000,000 in McDonald's, you would expect to collect $34,400 in dividend income per year at the current rate.  The 10-year Treasury bond yield, in contrast, is currently providing a return of 2.78%. 

3. Dividend Yield on Market vs. Dividend Yield on Cost

The current dividend yield is only half the story.  Unlike bond yields, which are based upon a bond paying a fixed rate of interest for the life of the bond, dividends for most successful companies increase over time.  Let's continue using McDonald's as an illustrative case study.  Take a look at the dividend it distributed to owners for the past six years prior the time period we just discussed (2013).  

Note: If you come across this article at some point in the future, don't worry because there is no need to update the figures as the basic concept behind dividend yield remains the same no matter the year and no matter the specific dividend amounts you uncover in your investment research process:

  • 2012 = $2.87 dividend
  • 2011 = $2.53 dividend
  • 2010 = $2.26 dividend
  • 2009 = $2.05 dividend
  • 2008 = $1.63 dividend
  • 2007 = $1.50 dividend

If you had bought McDonald's stock back in 2007, you've watched your dividends increase each and every year.  You're collecting far more than you originally anticipated based on the dividend yield on the purchase date.  In fact, during that year, the stock averaged almost exactly $53 per share, so imagine you had bought a single share.

On the day you paid for your stock, you were collecting $1.50 in dividends on a $53.00 stock, which is a dividend yield of 2.83%.  Over the past 12 months, you've collected a dividend of $3.24.  Comparing that $3.24 to the purchase price instead of the market price, you can calculate something known as "dividend yield on cost".  In this case, you're actually earning the equivalent of 6.11% per year on your original investment.  This can serve as a major driver of change in the stock price.

Companies that make their owners rich do so by continually earning more profit.  Often, these businesses have some sort of inherent economic advantage, like the Coca-Colas of the world, which can raise prices or expand into new markets.  The truly elite dividend payers on Wall Street, those businesses that have raised their dividend payouts to owners each year, without fail, for 25 years or longer, earn a title allowing them to be called a "Dividend Aristocrat".  McDonald's has expressed a commitment to raising its dividend so much, in fact, that we are now approaching the 40th year in a row that it has sent bigger checks to the stockholders.  That puts it in a league of its own among other blue chips on Wall Street.  Only a handful of other firms can boast such a sterling achievement.

4. Some High Dividend Stocks Are Traps Despite Their Seemingly-Attractive Dividend Yield Calculations

On the flip side of the equation are the dividend traps that ensnare inexperienced investors.  These are companies that look like they are going to make you a lot of money by boasting extremely high dividend yields - often many times what the stock market as a whole is offering.  Yet, sophisticated investors are not stupid.  They are avoiding the business for a reason.  Perhaps there is an enormous law suit that could bankrupt the company.  Maybe the financials indicate the dividend is not sustainable and will have to be cut.

One defensive move in a situation like this is to look at the dividend yield of a company relative to others in the industry.  If there is a single homebuilder offering a 14% dividend yield, something isn't right.  Either they are in financial trouble, there was a one-time special dividend that won't be repeated, or there is some other factor that you will need to research; a stock quote alone won't suffice.

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