How to Calculate Dividend Yield
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As an investor in the stock market, I am sure you have heard the term dividend yield at some point in the past.
Often referred to as the current yield, this financial ratio is a way to measure the cash flow an investor will get for each dollar they invest in a given security (or company). You could think of the dividend yield calculation as the return on investment (ROI) you will receive (in dividends) by purchasing a share of stock at the current share price.
The dividend yield for a company can be found on any investment website that provides financial data for companies. Investors can also find this information on a company’s website or can even calculate the ratio themselves.
Personally, I think it is a great idea to get your hands a little dirty and calculate the dividend yield every once in a while. In order to better understand the numbers, you need to know where they are coming from.
How to Calculate the Dividend Yield
The dividend yield of a stock can be calculated by dividing the annual dividends paid out by the current share price, as seen by the equation below.
Dividend Yield = Annual Dividends / Current Share Price
If company ABC is currently trading at $20 per share and has paid $1.00 in dividends over the past 12 months, the stock would be yielding 5.0%. The result of 5% was found by plugging in the annual dividend payments and the current share price into our equation, which is highlighted below.
ABC’s Current Yield = $1.00 Annual Dividends / $20 current share price
How to Use the Dividend Yield
In our previous equation, we found out that an investor who purchases shares of ABC at the current share price of $20 can expect to see a return on investment of 5% in dividends. While this ratio gives us plenty of useful information, it does not tell the whole story of the actual yield. There are several factors to consider when using the dividend yield of a stock.
First, since the share price is constantly moving up and down for a stock during a given trading period, the current yield fluctuates as well. For example, let us say that shares of ABC saw a recent spike in share price and rose to $25. Assuming the annual dividend has not changed, the new dividend yield of the stock dropped to 4% ($1 / $25) from 5%. On the other hand, if the stock price suddenly drops, the yield could shoot up above 5%.
The second thing to consider with the current yield is how annual dividends are paid. Most yield calculations use dividends paid to shareholders during the past 12 months. As we all know, the past is not necessarily an indication of the future. A stock with a sporadic dividend past could suddenly cut their distribution sending the current yield spiraling down. You certainly don’t want to be caught with a stock that decides to make one of these cuts.
Using the dividend yield of a stock can be very helpful to identify potential investments. However, once an investor purchases shares of the stock, the current ratio becomes irrelevant to the investor. Since the investor paid a specific price for the stock, it will no longer represent the current share price and will not give a true picture of their return on investment in the future. An alternative ratio that can help in this case is known as the yield on cost.
The ROI discussed above only represents the dividend payments received and does not consider any capital gains or losses.
The dividend yield is a simple financial ratio that represents a company’s potential cash return on investment. It can be used to help investors select quality income stocks. Investors who use this calculation should recognize any potential flaws in the numbers and factor it into their investment decisions.
Do you use dividend yield in your stock selection criteria? If so, what percentage yield do you look for?