What is a Dividend Yield?

The dividend yield is a key metric for stock investors who are interested in collecting dividends from stocks they own. It is expressed as a percentage and defines what you can expect to collect as a dividend in the future based on the price of the stock today. The dividend yield is calculated on an annualized basis, and is subject to change at any time by the company.

Before going further it might be helpful to define what a dividend is. A dividend is a payment made to shareholders that comes from a portion of the company’s profits. It can be paid at different intervals, typically monthly, quarterly, semi-annually, or annually. There are also special dividends which occur infrequently, often following a particularly profitable quarter.

How Does a Dividend Yield Work?

The dividend yield for a stock is one of the key facts that are included in a stock’s description. There are a lot of investors who seek out high dividend yields which can act as another form of cash flow in your brokerage account. Remember, the dividend yield is a forward-looking mechanism based on the current price of the stock. It tells you a picture of potential future income flow, but the company has the right to change its dividend yield at any time.

How to Calculate a Dividend Yield

For simplicity’s sake, let’s use round numbers to calculate a dividend yield for this hypothetical stock.

The formula to calculate the Dividend Yield is:

Dividend Yield = Annual Dividends Paid Per Share / Price Per Share

Since the formula is contingent on the price per share, we know that the dividend yield will always be fluctuating based on the divisor. Let’s take a look at an example using this formula.

Let’s say Company ABC is trading for $100 per share and pays an annualized dividend of $5.00 per share. What is the dividend yield?

Dividend Yield = $5.00 / $100.00 = 0.05 or 5.0%

For Company ABC, as long as the stock is trading at $100 per share, the dividend yield will be 5.0%.

If the price of Company ABC stock rose to $200 per share, then the dividend yield would fall to 2.5% and if the price dropped to $50 per share, the dividend yield would be 10%.

 

Which Industries Tend to Have a Higher Dividend Yield?

If you are seeking out a higher dividend yield, there are a few industries you can target. First, take a look at mature companies that are profitable and have good cash flow. Sectors like financials, industrials, and energy often pay high dividend yields because of their high cash flow. These companies often have steady business as well so for the most part, dividend payouts are safe.

Another industry you can target are REITs or Real Estate Investment Trusts. These are funds that own physical real estate buildings that they collect rent on. Legally, to be designated as a REIT, the company must pay at least 90% of their net earnings as dividends to shareholders. Why would a company do this? Tax benefits. REITs do not pay corporate tax on the dividends they pay out according to US financial law.

What is the Difference Between Dividend Yield and Payout Ratio?

We already covered what a dividend yield is so you might be wondering how this is different from a payout ratio. A payout ratio is a comparison between the dividend amount paid out and the company’s earnings per share. It is also measured as a percentage, and you can use this ratio to determine how likely a company is to be able to sustain a given dividend yield.

Here is the formula for calculating dividend payout ratio:

Dividend Payout Ratio = Annual Dividends Per Share / Earnings Per Share

Again, this will change from quarter to quarter based on the earnings that a company reports. As a general rule of thumb, you want to find companies with a dividend payout ratio around 30-50%. While 100% might seem impressive and lucrative to you, it actually means the company is paying out more dividends than profits made. If you think about it that way, that’s not a very healthy company and so you can reasonably assume the dividend yield is not going to be sustainable.

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