Dividend yield is a metric used by investors to evaluate dividend-paying stocks. But what exactly does dividend yield mean and how is it calculated?
Understanding dividend yield enables comparing dividend stocks on an apples-to-apples basis and assessing the income potential of an investment.
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Definition of Dividend Yield
Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price.
It is calculated by dividing the annual cash dividends per share by the current market price per share.
Calculating Dividend Yield
Dividend yield is calculated with the following formula:
Annual Dividends Per Share / Share Price = Dividend Yield
Company A pays $2 annual dividends per share It’s trading at $50 per share
$2 / $50 = 4% Dividend Yield
So Company A has a 4% dividend yield currently.
Interpreting Dividend Yield
A higher dividend yield signifies one of two things:
- The company pays higher dividends relative to its stock price
- The current stock price has fallen and caused the yield to rise
Looking at historical yields helps determine which reason accounts for spikes or drops in the current yield.
Using Dividend Yield to Compare Stocks
The main benefit of dividend yield is it standardizes different companies’ payouts for comparison:
- Stock A pays a $5 annual dividend at $100 per share price = 5% yield
- Stock B pays a $4 dividend at $80 per share price = 5% yield
So an investor can see Stock A and Stock B have equal 5% yields, making relative valuation easier.
Yields also help investors screen for stocks paying high sustainable dividends long-term.
Dividend Yield vs. Dividend Growth
Dividend yield only shows current income rate, not whether payments are growing over time.
Dividend growth measures how rapidly a company is increasing its payout each year – a key indicator of financial health.
The best dividend stocks offer both an attractive high yield and consistent dividend growth.
FAQs About Dividend Yield
Does higher dividend yield equal a better investment?
Not necessarily. Abnormally high yields above 8% could signal financial struggles. Seek sustainable dividend yields in the 2-6% range.
How is yield taxed?
Dividend yields represent income, which is taxed annually at either short term or preferential long term capital gains rates.
Where can I find a stock’s dividend yield?
Dividend yield can be found on most stock quote sites, brokerage platforms, and in stock screeners to search and compare yields.
What causes dividend yield to change?
Yields change as stock prices and dividend payments rise and fall. Yields may also change due to stock splits or dividends being cut.
Which has greater impact – price or dividends?
Stock price has a bigger impact. Dividend changes are usually gradual while prices can swing rapidly, significantly altering yields.
Understanding dividend yield allows investors to better evaluate the income potential of dividend stocks. Compare yields and dividend growth rates together for the full picture.