What It Measures
An investment’s dividend yield is a measure of the dividend paid on stock, expressed as a percentage over one year. This measure is frequently used in stock quotes and financial reports, and is based upon the company’s annual cash dividend per share and the current stock price.
Why It Is Important
A stock’s dividend yield is a crucial measure for potential investors in any company since it illustrates how much cash flow is generated for each dollar invested in equity, on top of any capital gains made from a rising stock price. A relatively high-paying, stable stock will attract income investors, and the higher the dividend yield, the greater expected return for income investors. Historical data also shows that stocks which pay a dividend have generally outperformed non-dividend-paying stocks in the long term.
How It Works in Practice
To calculate a dividend yield, you will need to use the following formula:
Dividend yield = Annual dividend per share ÷ Stock price per share
For example, Company A has an annual dividend per share of $10, and the average quarterly value of its stock per share is $75. To assess the company’s dividend yield, we would divide the dividend by the stock price, as follows:
10 ÷ 75 = 0.1333 = 13.33%
On this basis, the stock has a dividend yield of 13.33%.
Company B might also pay an annual dividend per share of $10, but if its stock is trading at $20 per share, then its dividend yield will be 50%—considerably higher than Company A’s dividend yield. Assuming other factors are equal, income investors would find Company B a more attractive investment opportunity.
Tricks of the Trade
The dividend yield helps to explain a company’s value to investors but can vary widely depending on a company’s market position, industry, earnings, cash flow, and dividend policy. Therefore, this measure is not always important for long-term investors who are concerned with a company’s long-term growth.
It isn’t a guarantee, but many studies show a strong correlation between yield and returns over five years—companies with higher yields tend to offer higher returns, while lower yields lead to lower returns.
It is common for newspapers to include yield figures in tables showing stock performance and share prices. In general, a yield of around 2–4% is considered average, and most attractive to longer-term growth investors.
High yields are generally offered by mature, well-established companies while younger companies tend to pay lower yields because they are focused on growth. Many young companies will not pay any dividend at all.
If a company has a low yield compared to others in the same industry, this could mean the company’s stock is over-valued because investors are confident of future growth. Alternatively, it can suggest that the company can’t afford to pay the expected dividends.
If a company has a high yield in comparison to others in the same sector, it could suggest imminent dividend cuts.