Dividend Yield - What Is It, Formula, How To Calculate, Importance (2024)

What is Dividend Yield?

The dividend yield ratio is the ratio between the current dividend of the company and the company's current share price – this represents the risk inherently involved in investing in the company. Investors seeking income from dividend stocks should maintain their concentration on stocks with at least a 3%-4% yield.

Dividend Yield - What Is It, Formula, How To Calculate, Importance (1)

High dividend yield stocks indicate how much a firm pays out in dividends about its market share price each year. It is a way to measure the cash flow ploughed back for every amount invested in the equity position. As there is no accurate capital gains information available, this yield on dividend acts as a potential return on investment for a given stock.

What is Dividend Yield?
- Dividend Yield Explained
- Formula
- Examples
- Why do some Stocks have a Higher Dividend Yield Ratio?
- Sectors
- Importance
- Forward vs. Trailing Dividend Yield Ratio
- Dividend Yield Ratio Video
- Recommended Articles

Dividend Yield Explained

The dividend yield ratio is an essential consideration for investors since it represents the annualized return a stock pays out in dividends. Investors should also consider the "Value Traps," which some stocks can offer to inflate their yields from dividends.

High dividend yield stocks, with say 10% or so, are considered risky since a dividend cut is very much on the cards. Investors should carefully choose their stocks and not keep all stocks only, which are high dividend-yielding in nature, as this can have a downside effect in the future.

One should also consider other macroeconomic factors such as the Government policies put in place and the economic and taxation policies in existence. If such policies are consistent, then their effects can be visible in the company's performance and the overall industry.

It is also represented as a company's total annual dividend payments divided by its market capitalization, assuming the number of shares is constant.

Formula

Let us understand the dividend yield calculator by first understanding the formula to calculate the dividend paid out by a company.

Dividend Yield ratio = Annual Dividends Per Share / Market Price Per Share.

Yields for the current year are generally estimated from the prior year's yield or latest quarter yield (annualized for the year) and division with the current share price.

Examples

Let us understand how high dividend yield stocks pay their investors every year in detail with the help of a couple of examples.

Example #1

Joe's bakery is an upscale bakery that sells a variety of cakes and baked products in the United States. Joe's is listed on a smaller stock exchange, and the current market price per share is $36.

Example #2

Company A's stock is currently being traded at $25 and pays an annual dividend of $1.50 to its shareholders. On the other hand, Company B's stock is trading at $40 in the stock market and pays an annual dividend of $1.50 per share.

In this case, Company A's dividend yield is 6% (1.50/25), while the yield for Company B is 3.75% (1.50/40).

Assuming all the other external factors remain constant. For example, an investor looking to make optimum usage from the client's portfolio to supplement their income will prefer the portfolio of Company A as it has a higher yield than Company B.

Investors who target having a minimum cash inflow from their investment portfolio can ensure this by making investments in stocks that regularly pay relatively high and stable dividend yields. It is a debatable statement that high dividends come at the cost of the firm's growth potential. It is because every currency amount paid to the shareholders in the form of dividends is an amount that the company is not plowing back with an effort to increase its market share. While being paid for retaining stock in the form of dividends may appear attractive to many (income), shareholders can earn a higher return if the value of their stock increases while they are holding on to it (growth). Hence, when a company pays dividends, it comes at a cost.

Example #3

Company ABC and Company PQR are valued at $5 billion, half of which comes from 25 million publicly held shares worth $100 each. Also, assuming that at the end of Year 1, the two companies earn 10% of their value or $1 billion in revenue. Company ABC decides to pay half of these earnings ($500 million) in dividends to its shareholders, paying $10 for each share to have a dividend yield of 10%. The firm also decides to reinvest the other half to make some capital gains, increasing its value to $5.5 billion ($5billion + $500million) and appeasing its income investors. Company PQR, on the other hand, decides to issue no dividends and reinvest all of its earnings into capital gains, thereby raising QPR's value to $6 billion ($5billion + $1 billion), likely encouraging the growth of investors.

Dividend yields measure an investment's productivity, and some view it as a Rate of interest earned on an investment. When companies pay large dividends to their shareholders, it can indicate various aspects of the firm. For example, the firm may be currently undervalued, or it is an attempt to attract a new and large number of investors. On the flip side, if a firm pays little or no dividends, it can indicate the company is overvalued or attempting to enhance the value of its capital. When they are established and earning steadily, certain firms in specific industries often indicate healthy yields on dividends despite being overvalued, e.g., banks and utilities, especially government-controlled.

While a company may be paying high dividends to its stakeholders over a steady period, the case may not always be the same. Companies often reduce their dividend distribution or halt them completely during difficult economic times or when the company is facing challenging times, so one cannot expect dividends to be a regular phenomenon from a shareholder's perspective.

Also, look at the Dividend Discount model for Valuations.

Why do some Stocks have a Higher Dividend Yield Ratio?

As investors in the stock market, it is often a subject for contemplation that some stocks are able to deliver higher returns in terms of dividends to their investors in comparison to others. Let us put the confusion to rest by understanding the intricate details of high dividend yield stocks.

Suppose one looks at the subprime mortgage downfall during 2007-09. In that case, some companies were offering dividends in the range of 10%-20%, encouraging the customers to cling to the stocks, but that was only because the stock's market price had seen a downward spiral, which resulted in a higher dividend yield ratio. Therefore, while analyzing a high-yield stock, it's always essential to determine the reason for the high yield of a stock.

There are 2 reasons why a stock may have an above-average yield:

#1 - The market price has taken a brunt

When a stock price falls quickly and the dividend payout remains equal the dividend yield ratio increases. For instance, if stock ABC were originally $60 with a $1.50, its yield would be 2.5%. If the stock price falls to $50 and the $1.50 dividend payout is maintained, its new yield will be 3%. It is to be noted that in the face of the situation, the yield may appear to attract dividend investors; it is a value trap. It is always essential to understand the high yield of a stock. A firm that shows a stock price falling from $50 to $20 is perhaps struggling, and one should make a detailed analysis before considering a plunge in the stocks.

#2 - Is it an MLP or REIT?

Master Limited Partnerships or Real Estate Investment Trusts are rapidly gaining popularity amongst dividend investors since they offer substantially higher dividend yield ratios than equity stocks. These trusts tend to offer high dividends since they must distribute a massive portion of their earnings (at least 90%) to shareholders in the form of dividends. These trusts do not pay regular income tax at the corporate level, but the tax burden is transferred to the investors.

Sectors

Some sectors in their design itself are more conducive to deliver higher dividends to their investors. It is important to understand that it is not an absolute guarantee that companies in these sectors would deliver high pay-outs but they most often do so.

Let us discuss the sectors that deliver high payouts according to the dividend yield calculator.

#1 - REIT Sector

The below graphs compare the dividend yield ratios of some of the REITs in the US – DCT Industrial Trust (DCT), Gramercy Property Trust (GPT), Prologis (PLD), Boston Properties (BXP), and Liberty Property Trust (LPT). REITs provide a stable yield (2.5%-5.2% in the example below).

Dividend Yield - What Is It, Formula, How To Calculate, Importance (2)

source: ycharts

#2 - Tobacco Sector

The tobacco sector in the US has also shown some stable yield ratios over the past 5-10 years. For example, in the graph below, we compared Philip Morris Intl (PM), Altria Group (MO), and Reynolds American (RAI). These companies have given stable dividends over the past 5-10 years.

Dividend Yield - What Is It, Formula, How To Calculate, Importance (3)

source: ycharts

Like REITs and Tobacco, other sectors like Telecommunications, Master Limited Partnerships, and Utilities also tend to show relatively higher dividend yield Ratios.

Importance

As an investor with a disciplined investing schedule, it becomes important to consider stocks that provide growth and regular side-income as well. To fit the brief perfectly, high dividend yield stocks have been employed for decades to do the job. Let us understand their importance through the discussion below.

Dividend-Paying Stocks are Stable

Dividend-paying stocks are very stable. It is pivotal to observe that one should keep a track-only of those shares which are constantly offering dividends to its shareholders. If a stock offers a high dividend in the first year and subsequently the yield is low or inconsistent, then such stocks should not be considered under the ambit of high dividend yielding. Historically, market prices of dividend-paying stocks weaken relatively lesser than various stocks having a lower Beta. The benefit of such stocks can stay tall during times of crisis when the stock market falls as they provide stability. They continue to extract dividends even in depressed market conditions, and additionally, such stocks tend to recover quickly from a downfall in the market. Hence, many investors prefer to buy such dividend-yielding stocks rather than sell them.

Resilience to Market Crash

There will be fewer buyers for dividend-yielding scripts than sellers as they are more lucrative. During scenarios of a crash, the market price of stocks tends to fall, but such dividend stocks will want to stand tall in the market by offering a reasonable amount of dividends. Investors will prefer to buy dividend-yielding stocks during a stock market slump to their portfolios.

Preferred by Value Investors

Value investors consider a high dividend yield ratio as a strong value indicator. If a quality stock is yielding a high dividend, then it is considered as undervalued. Improvement of sales and profit figures are one of the strongest fundamental indicators of quality stocks. An ideal situation from an investor's perspective will be high profitability and low debt. Such a situation though, will exist during the maturity stage of a firm. Normally, in developing countries, such a situation is not easily available, and most companies are keen on leveraging the high amount of debts on their balance sheets.

Considered Mature Companies

Companies that consistently distribute their profits in the form of dividends are considered established or saturated companies. This establishment comes with the predictability of future earnings. As a result, firms will never want to adjust their short-term liquidity to woo investors and shareholders. Generally, dividends are paid, indicating that they are in complete control of their liquidity position. Once its current liabilities are paid off, only then can a firm be in a position to offer dividends to its shareholders.

Reinvesting dividends enhances Yield.

Re-investing dividend further enhances the yield. Investors must invest in a systematic manner to accumulate dividend-yielding stocks. This way, not only do they accumulate fundamentally strong stocks to their portfolio but also increase overall dividend earnings. It is equally critical to reinvest dividend that flows in as this excess money can be used for purchasing more dividend stocks which are cyclical in nature. More stocks mean more dividends, which again is used for buying more stocks.

Forward vs. Trailing Dividend Yield Ratio

One can also anticipate the future dividend payment of a company, either by using the most recent annual dividend yield calculator usedby the firm or considering the most recent quarterly payment and multiplying the same by 4 to arrive at an annualized figure. Popularly known as "Forward Dividend yield," it has to be used cautiously since these estimates will always be uncertain. One may also compare such dividend payments about the stock's share price using a trend of the past 12 months to understand the history of the performance. Technically, it is referred to as the "Trailing Dividend Yield."

Forward Ratio

Forward yield estimates a particular year's dividend declared, Forward yield estimates a particular year's

The forward yield is calculated as Future Dividend Payment / Current Market Price of Share.

For instance, if a company pays a dividend in Q1 of 50 cents and assumes the firm will pay a constant dividend for the rest of the year, the firm is anticipated to pay $2 per share in dividends. If the stock price is $25, the forward dividend yield is

Trailing Ratio

The opposite of a forward yield is a "Trailing yield," which shows a company's actual dividend payments about its market share price of the previous 12 months. In a situation where the future dividends are not predictable, this method of yield determination can be relatively useful as a measurement of value.