Understanding Dividend Yield

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Not all of the tools of fundamental analysis work for every investor on every stock. If you are looking for high-growth technology stocks, they are unlikely to turn up in any stock screens you run looking for dividend paying characteristics. However, if you are a value investor or looking for dividend income then there are a couple of measurements that are specific to you. For dividend investors, one of the telling metrics is Dividend Yield.

Dividend Yield Definition

Dividend yield is a financial ratio that shows how much a company pays out in dividends every year in relation to its share price. Dividend yield is shown as a percentage and it's calculated by dividing the dollar value of dividends paid in a certain year per share of stock held by the dollar value of one share of stock.

Yields for a current year can be estimated using the previous year’s dividend yield or by utilizing the latest quarterly yield, multiplying it by 4, and dividing by the current share price.

Dividend Yield Formula

Dividend Yield = annual dividend per share / stock's price per share

For example, if a company’s annual dividend is $1.50 and the stock trades at $25, the Dividend Yield is 6%. ($1.50 / $25 = 0.06)

Understanding Dividend Yield

Dividend yield is a method to measure the amount of cash flow you're getting back for each dollar you invest in an equity position.

In other words, its a measurement of how much "bang for your buck" you are getting from dividends. Without any capital gains, the dividend yield is essentially the return on investment for a stock.

Here's a dividend yield example to explain the concept from Investopedia:

Suppose company XYZ's stock is trading at $20 and pays yearly dividends of $1 per share to its shareholders. Also suppose that company XYZ’s stock is trading at $40 and also pays annual dividends of $1 per share. This means that company ABC’s dividend yield is 5% (1 / 20 = 0.05), while XYZ’s dividend yield is only 2.5% (1 / 40 = 0.025). Assuming all other factors are equivalent, then, an investor looking to use his or her portfolio to supplement his or her income would likely prefer ABC's stock over that of XYZ, as it has double the dividend yield.

Investors who need a minimum cash flow from their investments can secure it by investing in stocks paying high, stable dividend yields. Older, well-established companies usually pay out a higher percentage than younger companies and their dividend history can be more consistent. However, high dividends can also cost a company in growth potential. Every dollar a company pays out to its shareholders in dividends is money that company is not reinvesting in itself to make capital gains. Getting paid for holding a stock is certainly an attractive proposition, shareholders can earn high returns if the value of their stock increases while they hold it.

Additional Articles in This Series

  1. Earnings per Share – EPS
  2. Price to Earnings Ratio – P/E
  3. Projected Earning Growth – PEG
  4. Price to Sales – P/S
  5. Price to Book – P/B
  6. Dividend Payout Ratio
  7. Dividend Yield
  8. Book Value
  9. Return on Equity

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