Dividend Yield

Definition

The dividend yield shows how much a company pays in dividends per year relative to the price of the underlying asset that pays out the dividend. It’s listed as a percentage and is presented as a financial ratio. The word “yield” is often used in fixed income investing to convey how much an asset is paying out just to hold it outright.

Calculations

The dividend yield formula is as follows:

Dividend yield = annual dividends per share : price per share

We usually calculate the dividend yield from the financial report of the full last year. Keep in mind that the longer it’s been since the company’s annual report, the less relevant the data is going to be for investors.

To decide how to go about calculating the dividend yield, investors should consider and analyze the history of company dividend payments in order to help them choose which method of calculation will be most effective for them and provide the most accuracy.

Takeaways

The dividend yield is the amount of money that a company pays its shareholders in return for them owning a share of the company’s stock, then divided by the company’s current stock price. Some companies will pay higher dividends than others, and can even have their dividends taxed at a higher rate. 

The analysis of dividend yields is used often when investors are searching for companies to invest in. Dividend yield is often desired by fixed income investors. Companies such as Real estate investments trusts, business development companies, and master limited partnerships are all likely to pay higher dividends on average because the U.S. Treasury requires that companies such as these pay the majority of their income to their shareholders. Instances such as these are called the “pass-through” process and allow the company to forgo income taxes on profits that it then pays to shareholders as dividends. Shareholders, however, do have to pay taxes on their income profit.

Keep in mind that higher dividend yields don’t always point towards good investment opportunities. There are cases where companies have high dividend yields due to a decline in stock price, and not because they are highly profitable.

What to look for

If the dividend yield remains where it is and does not rise or decline in percentage, then it is safe to assume that the yield will rise when the stock price falls. On the other hand, if the stock price rises, the dividend yield will fall. The dividend yield changes relative to the stock price, and therefore it may present itself as uncharacteristically high when stocks are quickly falling in value.

The dividend yield is shown as a percentage rather than a dollar amount to make it simpler to see the amount of return the shareholder of a company can expect to make relative to what they have invested. The yield, in general, shows how much a company pays out in dividends each year.

Limitations

Dividends may come at the expense of necessary or potential growth of a company, as each dollar a company pays through dividends is a dollar that the company cannot therefore reinvest within. As explained above, it is not in an investor’s best interest to analyze a stock solely based on the dividend yield. In addition, investors should be wary of a company that looks as though it is declining, all the while with a high dividend yield. The stock price is the denominator of the formula and used to calculate the dividend yield. 

Summary

The dividend yield is a percentage that shows the amount in which a company pays in dividends per year, relative to the company’s stock price. The yield can be used with other indicators to aid analysis and should not be an investor’s sole focus due to instances that showcase insufficient or irrelevant data to a company’s stock price.

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