What’s Dividend Yield All About?

We’ve said it before, but we’ll say it again: Before you purchase any stock, it’s important to do some research. But what should you look for? There are lots of different numbers to help you understand a company’s operations, such as revenue, profit, and losses. We’ve explained P/E ratio, which can help you determine a company’s value relative to other companies in its industry.

Another important metric to consider is something called the dividend yield. It can help you measure how much cash you’ll get back in dividends for every dollar you invest in the company.

Many of the best-known and largest public companies in the U.S. pay dividends, and if you invest in them, dividends become part of your earnings.  In fact, going back to 1962, 82% of total returns for the S&P 500 can be attributed to reinvested dividends, according to recent research.

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Here’s an example of what the formula looks like:

Tactics and considerations

• You can easily find a company’s dividend yield on financial websites with stock information.
• You can also do your own calculation: Check out a company’s 10-k, or annual report, Where it will report what it paid in annual dividends. Then you divide the annual dividend by the current share price to get the dividend yield.
• There’s no one schedule for how often a company pays dividends. Some companies might pay once a year, others might pay twice a year. Others might pay you every quarter. To figure out the annual dividend, multiply the dividend amount by the number of payments annually.
• The dividend yield of a stock is directly affected by the company’s share price. In fact, there is an inverse relationship. When a company’s stock price goes up, the yield will go down. And when the share price goes down, yield will go up.
• Consideration: Does a high yield mean a company is worth investing in? Not necessarily–it could mean additional risk. When a company’s stock price drops compared to its dividend, the yield will increase. Also, think about this: The average dividend yield for the S&P 500, which includes some of the largest and most successful companies in the U.S., is less than 2%. 
• Find out more about dividends here and here.

Examples

We love our imaginary widget maker Acme Co.

1-Let’s say Acme pays an annual dividend of $1. It’s current stock price is $30 a share. Its dividend yield would be 3.3%.

1/30=.033, or 0.033X100=3.3%

2-Now let’s say Acme continues to pay an annual dividend of $1, but it’s share price goes up to $40. Its dividend yield will decrease, to 2.5%.

1/40=0.025, or 0.025×100= 2.5%

3-Acme encounters trouble and its stock falls to $20, but it keeps its dividend the same, at $1. Its dividend yield would actually increase to 5%. In that case, the higher dividend yield could be deceiving, because the stock has fallen.

1/20=0.05, or 0.05X100=5%

4-Acme has a great year and its stock increases to $60 a share. It also increases its annual dividend to $6. Its yield would be 10%, possibly a good deal when you consider the increasing stock price and dividend.

6/60=0.1, or 0.1×100=10%

No one can predict the future, but by looking at a company’s stock price and dividend yield it can help you understand a company’s performance, and how your return will be affected by dividend payments. Used in conjunction with the P/E ratio and other earnings numbers, you can begin to have a better picture of a company and its performance before you invest.