How to Calculate Dividend Yield (Plus Definition and Examples)
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If you're hoping to increase your investments, it's essential to understand the significance of the dividend yield. Investors can measure dividend yield by dividing the amount of money a company pays shareholders for owning their stock by its current market value. Understanding dividend yield in detail can help you get the most value from your stocks and plan your future investments accordingly. In this article, we define what a dividend yield is and share a step-by-step on how to calculate it, along with several example calculations to help you understand the concept better.
What is a dividend yield?
The dividend yield, or dividend-price ratio, is a ratio that indicates the amount of money a firm pays out in cash dividends annually as a percentage of its current market value per share price. Basically, this is the quantity of money a company offers their shareholders for holding its stock divided by its current share price. While companies tend to pay dividends quarterly, it's also essential to factor in an annual amount when calculating dividend yield, since it's expressed as an annualised percentage.
Dividend payments provide a relatively dependable revenue stream for several investors. Therefore, they may evaluate two more dividend values of stocks before investing. These include:
Trailing dividend yield: It gives the dividend percentage paid over a previous period, generally one year. While this dividend can be indicative of future dividends, it can also be misleading, since it doesn't account for dividend increases or cuts.
Forward dividend yield: It's an estimation of the future yield of a stock. Investors can base this value on analyst estimates or use the company's guidance.
How to calculate dividend yield
If you've invested in stocks, you may often wonder how to calculate dividend yield, since finding the dividend yield can help you compare stocks and determine the most worthwhile investment strategy. Here's the formula and steps to calculate dividend yield:
1. Find the dividend per share
Dividend per share refers to a company's annual dividend payment. This is different from the market value per share, which is the company's current share or stock price. Generally, companies pay out dividends every quarter. As a result, you can add each quarter's dividend payout to determine the annual dividend payment.
For instance, if a company is paying $0.30 per share each quarter, you can calculate $0.30 x 4, which results in an annual dividend per share of $1.2. If you're calculating the dividend per share on a monthly basis, you can multiply the payment amount by 12 to get an annualised dividend per share.
2. Determine the market value per share
The next step is to find the company's current market value per share. The market value of a share is the amount the company currently trades in the stock market. Since this value fluctuates frequently, ensure to update the latest amount in your dividend yield calculation to get the right value.
3. Calculate the dividend yield
After identifying the annual dividends per share and the market value per share, you can use the below formula to find the dividend yield:
Dividend yield = Annual dividends per share / Market value per share
For example, suppose a company has a market value per share of $50 and an annual dividend value per share of $1.2. Using the above formula, we can find out that the dividend yield is 0.024. Companies usually represent their dividend yield in percentage. So, we can multiply 0.024 by 100 to obtain the dividend yield percentage of 2.4%. This implies every investor can earn 2.4% via dividends from the company's share.
Interpretations of the dividend yield formula
The dividend price ratio formula can help determine the cash flows allotted to an investor when they own shares or stocks of a company. The value of the yield depends on various factors, such as the company's business life cycle and the industry where it belongs. For example, new and relatively smaller companies expanding rapidly may offer a lower than average dividend compared to well-developed companies in the same industry. These young companies may reinvest the money to grow their business further.
In contrast, a mature company may offer a higher yield, especially if they aren't developing rapidly. The yield ratio may not necessarily indicate a good or bad company. Instead, investors use it as a measure to identify the best stocks that align with their investment strategies. Common industries that generally offer higher dividends include real estate, utilities, consumer staples, energy and telecommunications.
Importance of dividend yield
One of the most critical reasons to understand the dividend price ratio is to identify stocks that offer the highest returns in investment. Here are some other benefits you may consider:
Compare different stock investment strategies easily
If you're an income investor, select and compare stocks to find the ones that can offer the maximum dividend for each dollar that you invest. For example, consider two companies that pay a similar annual dividend of $3 per share, the first company's stock value is $60 per share, and the second company's stock value is $120 per share. In such situations, income investors may prefer the first company since their dividend yield is 5% compared to the second company's yield, which is just 2.5%.
Keep in mind that the stock market can be extremely volatile. It's important to consult professionals and conduct research before making any investment decisions.
Offer a better understanding of the company's financial health
If a firm raises its dividend, increasing its dividend-price ratio, this typically indicates that the business is doing reasonably well and they're capable of offering a higher percentage of their returns to shareholders. Normally, mature companies in established industries tend to offer better dividend-price ratios. Meanwhile, fast-growing younger companies prefer to reinvest their gains for further business development instead of expending a higher dividend.
Though calculating the dividend yield can be helpful, sometimes investors may face issues if they solely rely on dividend yield as the basis for making decisions about their investments. It's also beneficial to consider if the dividend-price ratio has been consistent over the past years. Often, a sudden change in stock price may affect the dividend yield, and if a company is paying a higher dividend, it may hinder its ability to grow.
Grow your returns
Instead of cashing in on your returns every quarter or year, consider reinvesting the dividends. Over time, your returns may increase drastically due to the benefits of the compounding effect.
Remember that the dividend yield ratio is only one of the several important parameters that investors use to evaluate companies before purchasing their stocks. In addition, the dividend yield rate varies across industries. For example, information technology or electronics usually have a negligible dividend yield when compared to real estate, which usually offers a stable dividend yield. Finally, it's important to understand that strong fundamentals and stability in dividend yield are only a few indicators for purchasing a stock. Investors may also consider other macroeconomic factors, such as inflation, retail sales and government policies, before investing.
Examples of calculating dividend yield
Here are a few examples to guide you while calculating the dividend-price ratio:
Here's an example of a dividend-price ratio calculation:
Max Company trades at a price of $40. They paid $0.40 per share each quarter in dividends throughout the year. Therefore, the company's total dividend payment for the year is $0.40 multiplied by 4, which equals $1.6. Next, divide that total by the market value per share of $40. This provides the company with a dividend yield of 0.04 or 4%, which implies investors can earn 4% via dividends from the company's shares.
Consider the example of another company that trades at $120 and pays $5 per share in each quarter:
The total dividend payment for the year is $5 multiplied by 4, which results in $20. Next, divide $40 by the market value per share of $120. This gives the company a dividend yield of 0.166 or 16%.
Here's another company that trades at a price of $100 and pays $0.50 per share each month in dividends:
Multiply the monthly share amount by the number of payments each year, or $0.50 by 12, to get an annualised dividend payment of $6. Next, divide $6 by the market value per share of $100 to result in a dividend yield of 0.06 or 6%.
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