Dividend Yield

Overview

Dividend Yield is the amount of dividend that a company pays (on an annual basis) expressed as a ratio compared to the company's current stock price. It is expressed as a percentage and indicates the attractiveness of investing in a company's stocks purely based on dividend return, and it is an important ratio for income-type investors.

Formula

Calculation: Dividend yield is calculated by dividing the annual dividend per share amount that the company pays by the current value of the company's share. The result is expressed as a percentage, showing the return on investment from dividends relative to the stock price.

Inverse Correlation with Stock Price: From the formula, it follows that the dividend yield will be inversely correlated with the stock price. So, assuming the dividend per share is not increased or lowered, when the stock price on a company is rising, the dividend yield will fall. Inversely, when the stock price is falling, the dividend yield will be rising. This means a lower stock price increases the yield, and a higher stock price decreases the yield, assuming the dividend payment remains constant.

Calculation Example

Let's calculate the dividend yield for a hypothetical company to demonstrate the process and show the inverse relationship with stock price:

How to Interpret

Since dividend yield is the amount that a company is paying back to investors, it makes sense that the higher the number, the better for individual investors. There are some caveats to that though.

What is a Good Dividend Yield:

Why It Matters

Paying a dividend is one of the direct ways a company can return funds to the investors. Dividend yield is particularly important for income-focused investors who rely on consistent cash returns from their investments.

Key Insights:

• Direct Return Measurement: Paying a dividend is one of the direct ways a company can return funds to investors. Dividend yield quantifies this return as a percentage, making it easy to compare the income potential across different investment opportunities. It shows exactly how much cash return you are receiving relative to your investment amount.
• Income Per Dollar Invested: If you are investing in a stock for the income and are seeking consistent returns every year, the dividend yield will show you how much you are earning for each dollar invested in the company (at the specific stock price). For example, a 5% dividend yield means you earn $5 in annual dividends for every $100 invested. This makes it straightforward to plan and forecast income from your investment portfolio.
• Company Maturity Indicator: Consistent dividend-paying companies are usually older and more mature businesses, usually from sectors like utilities or consumer staples. These companies have established cash flows and fewer growth opportunities requiring reinvestment, so they return more cash to shareholders. Dividend yield helps identify these stable, income-generating investments suitable for conservative portfolios.
• Growth Stage Assessment: New and relatively small, still-growing businesses usually do not pay dividends, or if they do, it is a lower percentage of their earnings as they are better off investing those funds in growing the business. A low or zero dividend yield typically signals a growth-focused company reinvesting profits for expansion. This helps investors distinguish between income investments (high yield) and growth investments (low or no yield), allowing them to align investments with their financial goals.

Key Takeaways

• Dividend yield is amount of dividend company pays (annual basis) as ratio compared to current stock price
• Expressed as percentage, indicates attractiveness of investing in company stocks purely based on dividend return
• Important ratio for income-type investors seeking consistent cash returns
• Formula: Dividend Yield Ratio = Annual Dividend per Share ÷ Market Value per Share
• Inversely correlated with stock price: when stock price rises, dividend yield falls (assuming dividend unchanged)
• When stock price falls, dividend yield rises (assuming dividend unchanged)
• Lower stock price increases yield, higher stock price decreases yield (assuming constant dividend payment)
• Higher dividend yield generally better for income investors (more cash returns relative to stock price)
• Unusually high yield may signal stock price has fallen significantly, could indicate underlying business problems
• Must assess sustainability and predictability of future dividend payments before investing
• Check dividend payout ratio, dividend payment history, and overall future business prospects
• Sustainable dividend supported by strong cash flows, reasonable payout ratios (typically below 80%), consistent history
• Consistent dividend payers usually older mature businesses from sectors like utilities or consumer staples
• New/small/growing businesses usually do not pay dividends or pay lower percentage (reinvesting for growth)
• Paying dividend is direct way company returns funds to investors
• Shows how much earning for each dollar invested in company at specific stock price