Dividend yields are the financial ratio measuring the dividend paid out by a company relative to the current market value of the shares owned. It’s important for investors because it allows them to see their return on investment or their expected return if they are deciding whether to invest in a share.
When you invest in stocks you can earn a return by either dividend payments, or stock appreciation.
Dividends are common because the regular payouts provide a level of certainty about the financial wellbeing of a company and are attractive to investors who want to generate a steady income from them.
Some companies, like Amazon, do not pay dividends and invest the profits back into the business. This type of share is known as a growth stock.
Using the dividend yield formula you can analyze the return on investment for a given stock.
Dividend Yield Excel Template
Want to calculate the dividend yield yourself in Excel? Download the free dividend yield excel template below.
Dividend Yield Formula
The dividend per share is most often available in the company’s financial statement of retained earnings. However, they can sometimes be reported as gross dividends distributed.
With gross dividends distributed, you can find the per share dividend by dividing the total dividend payments by the total weighted-average number of shares.
The current market value of the share used in the dividend yield formula is calculated by simply looking up the open stock exchange price as it was on the last day of the year or period.
Dividend Yield Analysis
So, an investor can use the above dividend yield formula to work out the cash flow they receive from investing in stocks. Put simply, the dividend yield ratio shows them how much dividend they get for every dollar the stock is worth.
The formula is very useful for investors looking at the increase or decline of the dividend yield for a stock. Why? A company paying less dividend relative to its price could be in trouble (although they could also be retaining more profit instead of paying out a dividend).
Savvy investors will evaluate a stock and consider the overall company – including its net profit. A low dividend yield where the company is reinvesting profits could still be valuable because the reinvestment into the company could substantially increase the price of the stock.
Dividend Yield Example
To understand the dividend yield ratio and formula a little better, let’s try an example.
Magnolia Bakery is a world-renowned bakery in New York City, known for its classic American baked goods and desserts. They are listed on a smaller stock exchange with a current market price per share of $25.
In the previous year, Magnolia paid out $20,000 in dividends, with 1,000 outstanding shares. Let’s work out the dividend per share:
Once we have the dividend per share, we can then use the dividend yield formula to calculate the ratio:
This means that for every $1 invested into Magnolia Bakery, the investors are getting back $0.80. This means that the investors are getting an 80% annual return on their investment.
Forward Dividend Yield
You can also anticipate the future dividend payment of a company by using the forward dividend yield ratio. Use this ratio and formula with caution though, because the estimates are just that.
A forward dividend yield is an estimation of a year’s dividend declared, shown as a percentage of the current market price.
So, for instance, if a company in Q1 pays a dividend of $0.40 (and we assume it will pay a constant dividend until year-end) then it can be expected to pay $1.60 per share in dividends for the rest of the year.
If the stock price is $30, the forward dividend yield becomes:
Dividend Yield Conclusion
Dividend-paying stocks are generally very stable, and the dividend yield ratio allows investors to track those stocks and their level of yield over time.
If during the first year of investment, a stock offers a high dividend yield but then declines over time, it may not be the right stock to invest in if you’re looking for a high dividend yielding.
Investors should be using the dividend yield ratio as part of their strategy, looking in particular at the following points while they have dividend stocks in their portfolio:
- The dividend yield is important because it represents your annual return on investment
- Investors who want an income from dividend stocks should be looking for at least a 3-4% yield
- If a stock offers a yield of more than 10% it should be considered high risk because the company will likely cut the dividend (which is generally a signal to sell the stock)
Dividend Yield Calculator
You can use the dividend yield calculator below to work out your ratios.
1. What is the dividend yield?
The dividend yield is the percentage of the current share price that is paid out in dividends per year. For example, a company that pays out $0.50 in dividends for every share that is owned would have a dividend yield of 20%.
2. How is the dividend yield calculated?
The dividend yield is calculated by dividing the annual dividend payment by the current share price. For example, if a company pays out $1 in dividends for every share that is owned, the dividend yield would be 100%.
3. What is a good dividend yield?
A good dividend yield is one that is greater than 3%. This ensures that the investor is receiving a significant return on their investment.
4. What are the advantages and disadvantages of dividend yields?
The advantages of dividend yields are that they provide a stable and regular income for the investor and that they are a sign of a strong and healthy company. The disadvantage of dividend yields is that they can be indicative of a stock that is overvalued.
5. Why is the dividend yield important?
The dividend yield is important because it represents the annual return on investment for the investor. This allows the investor to compare different stocks and make an informed decision about which stock to invest in.