Dividend Yield

Loading the player...

What is the 'Dividend Yield'

A financial ratio that indicates how much a company pays out in dividends each year relative to its share price. Dividend yield is represented as a percentage and can be calculated by dividing the dollar value of dividends paid in a given year per share of stock held by the dollar value of one share of stock. The formula for calculating dividend yield may be represented as follows:

Dividend Yield

Yields for a current year are often estimated using the previous year’s dividend yield or by taking the latest quarterly yield, multiplying by 4 (adjusting for seasonality) and dividing by the current share price.

As an alternative for calculating dividend yield, you can use Investopedia’s own dividend yield calculator.

BREAKING DOWN 'Dividend Yield'

Dividend yield is a way to measure how much cash flow you are getting for each dollar invested in an equity position. In other words, it measures how much "bang for your buck" you are getting from dividends. In the absence of any capital gains, the dividend yield is effectively the return on investment for a stock.

To better explain the concept, refer to the following dividend yield example. Suppose company ABC’s stock is trading at $20 and pays annual dividends of $1 per share to its shareholders. Also suppose that company XYZ’s stock is trading at $40 and also pays annual dividends of $1 per share. This means that company ABC’s dividend yield is 5% (1 / 20 = 0.05), while XYZ’s dividend yield is only 2.5% (1 / 40 = 0.025). Assuming all other factors are equivalent, then, an investor looking to use his or her portfolio to supplement his or her income would likely prefer ABC's stock over that of XYZ, as it has double the dividend yield.

Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in stocks paying relatively high, stable dividend yields. Yet, high dividends may often come at the cost of growth potential. Every dollar a company is paying in dividends to its shareholders is a dollar that company is not reinvesting in itself in an effort to make capital gains. While being paid for holding a stock is attractive to many, and for good reason, shareholders can earn high returns if the value of their stock increases while they hold it. In other words, when companies pay high dividends it may come at a cost.

For example, suppose company ABC and company XYZ are both valued at $1 billion, half of which comes from 5 million publicly held shares that are worth $100 each. Also suppose that at the end of Year 1 the two companies both earn 10% of their value, or $100 million, in revenue. Company ABC decides to pay half of these earnings ($50 million) in dividends to its shareholders, paying $10 for each share for a dividend yield of 10%. ABC also decides to reinvest the other half to make some capital gains, raising the value of the company to $1.05 billion and appeasing its income investors. Company XYZ, on the other hand, decides to issue no dividends and reinvest all of its earnings into capital gains, thereby raising XYZ’s value to $1.1 billion, likely appeasing its growth investors.

If these companies continue these policies at the same rates and continue to earn 10% of their value during Year 2, investors holding shares of ABC will see even greater dividend payouts, earning $10.50 per share ($1.05B x 10% = $105M, $105M / 2 = $52.5M, $52.5M / 5M = $10.50) at the end of Year 2 for a dividend yield of 10.5%. At the end of Year 2, company ABC will be worth $1.155 billion and has continued to keep its income investors happy, but by the same time company XYZ will be worth $1.21 billion. If these policies continue, by the end of Year 3 company ABC will be worth $1.213 billion and company XYZ will be worth $1.331 billion. Both companies are growing in value exponentially, but XYZ is growing at double the speed of ABC and will reach double its original value during Year 8, whereas ABC will do so in Year 14. By the end of Year 10, ABC will be worth $1.706 billion and XYZ will be worth $2.594 billion, or 52% more than ABC. Though this example is very simplified and an unlikely situation, it illustrates the drawbacks for a company that may accompany high dividend payments.

When companies pay high dividends to their shareholders, it can indicate a variety of things about the company, such as that the company might currently be undervalued or that it is attempting to attract investors. On the other hand, if a company pays little or no dividends, it may indicate that the company is overvalued or that the company is attempting to grow its capital. Certain companies in particular industries, when they are well established and steady-earning, often have good dividend yields even though they are not undervalued. Banks and utilities often fall into this category.

While a company may pay high dividends to its shareholders for a time, this may not always be so. Companies often trim their dividend payments or stop them altogether during hard economic times or when the company is experiencing hard times of its own, so one can rarely rely on consistent dividends on a permanent basis.

One can extrapolate information about a company’s dividend payments to estimate a company’s future dividends, either by using the most recent annual dividend payment or by taking the most recent quarterly payment and multiplying by 4. This is often referred to as the “forward dividend yield,” although one should use it with caution, as estimates of future dividend payments are inherently uncertain. One may also compare dividend payments relative to a stock’s share price over the past 12 months to better understand the history of its performance, and this is often referred to as the “trailing dividend yield.”

Interested in learning more about Dividend Yield? You may want to read Investment Valuation Ratios - Dividend YieldThe Power Of Dividend Growth and Your Dividend Payout: Can You Count On It?

RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Yield On Cost - YOC

    The annual dividend rate of a security divided by the average ...
  5. Dividend Rate

    The total expected dividend payments from an investment, fund ...
  6. Indicated Dividend

    The total dividends that would be paid on a share of stock throughout ...
Related Articles
  1. Markets

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  2. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  3. Investing

    Dividend Yield For The Downturn

    High-dividend stocks make excellent bear market investments, but the payouts aren't a sure thing.
  4. Options & Futures

    Stock-Picking Strategies: Income Investing

    Income investing, which aims to pick companies that provide a steady stream of income, is perhaps one of the most straightforward stock-picking strategies. When investors think of steady income ...
  5. Stock Analysis

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
  6. Trading Strategies

    Introduction To Dividends: Doing Your Homework And Taxes

    Similar to any other investments, it is important to perform due diligence prior to making any dividend-related decisions. There are several factors to consider when researching and selecting ...
  7. Investing Basics

    The Risks of Chasing High Dividend Stocks

    Dividend stocks offer enticing yields, but a lot can go wrong on the way to collecting that dividend payout.
  8. Stock Analysis

    These Companies Have Raised Their Dividends for 50 Consecutive Years

    Imagine if you had bought these stocks 20 years ago. If you had, then right now you'd be earning dividend yields of... 27%... 33%... even as high as 65%. And that's from brand name companies ...
  9. Investing Basics

    Reinvesting Dividends Pays in the Long Run

    Find out why dividend reinvestment is one of the easiest ways to grow wealth, including how this tactic can increase your investment income over time.
  10. Stock Analysis

    Solid Dividend-Paying Companies

    If you are looking to add dividends to your portfolio, don't miss these stocks.
RELATED FAQS
  1. What can cause the marginal propensity to consume to change over time?

    Learn about the dividend payout ratio and dividend yield, what the ratios measure and the difference between the dividend ... Read Answer >>
  2. Why would a stock that pays a large, consistent dividend have less price volatility ...

    To understand the differences in volatility commonly seen in the stock market, we first need to take a clear look at exactly ... Read Answer >>
  3. What metrics should I evaluate when looking for high-yielding dividend stocks?

    Evaluate high-yield dividend stocks to determine if they are a good investment to produce steady income. Learn what questions ... Read Answer >>
  4. What is the difference between the dividend yield and the dividend payout ratio?

    Learn the differences between a stock's dividend yield and its dividend payout ratio, and learn why the latter might be a ... Read Answer >>
  5. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
  6. Which companies in the chemicals sector pay the highest dividends?

    Learn what the average annual dividend yield of insurance companies is and which factors should be considered when choosing ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center