Dividend Yield

Dividend yields are the financial ratio measuring the dividend paid out by a company relative to the current market value of the shares owned. It’s important for investors because it allows them to see their return on investment or their expected return if they are deciding whether to invest in a share.

When you make an investment in stocks you can earn a return by either dividend payments, or stock appreciation.

Dividends are common because the regular payouts provide a level of certainty about the financial wellbeing of a company and are attractive to investors who want to generate a steady income from them.

Some companies, like Amazon, do not pay dividends and invest the profits back into the business. This type of share is known as a growth stock.

Using the dividend yield formula you can analyze the Return on Investment for a given stock.

Dividend Yield Formula

Dividend\:Yield = \dfrac{Dividend\:per\:Share}{Current\:Share\:Price}

The dividend per share is most often available in the company’s financial statement of retained earnings. However, they can sometimes be reported as gross dividends distributed.

With gross dividends distributed, you can find the per share dividend by dividing the total dividend payments by the total weighted-average number of shares.

The current market value of the share used in the dividend yield formula is calculated by simply looking up the open stock exchange price as it was on the last day of the year or period.

Dividend Yield Analysis

So, an investor can use the above dividend yield formula to work out the cash flow they receive from investing in stocks. Put simply, the dividend yield ratio shows them how much dividend they get for every dollar the stock is worth.

The formula is very useful for investors looking at the increase or decline of the dividend yield for a stock. Why? A company paying less dividend relative to its price could be in trouble (although they could also be retaining more profit instead of paying out a dividend).

Savvy investors will evaluate a stock and consider the overall company – including its net profit. A low dividend yield where the company is reinvesting profits could still be valuable because the reinvestment into the company could substantially increase the price of the stock.

Dividend Yield Example

To understand the dividend yield ratio and formula a little better, let’s try an example.

Magnolia Bakery is a world-renowned bakery in New York City, known for its classic American baked goods and desserts. They are listed on a smaller stock exchange with a current market price per share of $25.

In the previous year, Magnolia has paid out $20,000 in dividends, with 1,000 outstanding shares. Let’s work out the dividend per share:

Dividend\:per\:Share = \dfrac{\$20{,}000}{1{,}000} = \$20

Once we have the dividend per share, we can then use the dividend yield formula to calculate the ratio:

Dividend\:Yield = \dfrac{\$20}{\$25} = 80\%

This means that for every $1 invested into Magnolia Bakery, the investors are getting back $0.80. This means that the investors are getting an 80% annual return on their investment.

Forward Dividend Yield

You can also anticipate the future dividend payment of a company by using the forward dividend yield ratio. Use this ratio and formula with caution though, because the estimates are just that.

A forward dividend yield is an estimation of a year’s dividend declared, shown as a percentage of the current market price.

Forward\:Dividend\:Yield = \dfrac{Future\:Dividend\:Payment}{Current\:Share\:Price}

So, for instance, if a company in Q1 pays a dividend of $0.40 (and we assume it will pay a constant dividend until year end) then they can be expected to pay $1.60 per share in dividends for the rest of the year.

If the stock price is $30, the forward dividend yield becomes:

Forward\:Dividend\:Yield = \dfrac{\$1{.}60}{\$30} = 5.34\%

Conclusion

Dividend-paying stocks are generally very stable, and the dividend yield ratio allows investors to track those stocks and their level of yield over time.

If during the first year of investment, a stock offers a high dividend yield but then declines over time, it may not be the right stock to invest in if you’re looking for high dividend yielding.

Investors should be using the dividend yield ratio as part of their strategy, looking in particular at the following points while they have dividend stocks in their portfolio:

  • The dividend yield is important because it represents your annual return on investment
  • Investors who want an income from dividend stocks should be looking for at least a 3-4% yield
  • If a stock offers a yield of more than 10% it should be considered high risk because the company will likely cut the dividend (which is generally a signal to sell the stock)

Dividend Yield Calculator

You can use the dividend yield calculator below to work out your own ratios.