Dividend Yields Ratio
Definition of Dividend Yield: Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price. It's expressed as a percentage and represents the return on investment for a stock's dividends alone.
Formula for Dividend Yield: Dividend Yield = Annual Dividends per Share / Current Stock Price
Detailed explanation of the formula:
- Annual Dividends per Share: This is the total amount of dividends paid out by the company over a year, per share of stock. If a company pays quarterly dividends, you would sum the four quarterly payments.
- Current Stock Price: This is the current market price of a single share of the company's stock.
To calculate the ratio:
- Find the total dividends paid per share over the last year.
- Determine the current market price of a single share.
- Divide the annual dividends by the current stock price.
- Multiply by 100 to express as a percentage.
For example: If a company pays annual dividends of $2 per share and its current stock price is $50:
Dividend Yield = ($2 / $50) x 100 = 4%
This means the stock yields 4% in dividends annually based on the current price.
Company Dividend Yield:
- Specific to an individual company
- Reflects the company's dividend policy and current stock price
- Useful for evaluating income potential from a specific stock
Industry Dividend Yield:
- An average or median of dividend yields for companies within a specific industry
- Calculated by taking the dividend yields of all dividend-paying companies in the industry and finding the average or median
- Serves as a benchmark for comparing individual companies within that industry
How to look at Dividend Yields while investing in the stock market:
- Income vs. Growth: Higher yields may indicate stronger income potential, but could also suggest limited growth prospects.
- Yield Sustainability: Consider whether the company can maintain or grow its dividend based on earnings and cash flow.
- Payout Ratio: Look at the percentage of earnings paid out as dividends. A very high ratio might be unsustainable.
- Industry Comparison: Compare a company's yield to its industry average. Some industries (e.g., utilities) typically have higher yields than others (e.g., tech).
- Interest Rate Environment: In low interest rate environments, dividend yields become more attractive compared to bonds.
- Tax Considerations: Be aware of how dividends are taxed in your jurisdiction compared to other forms of investment income.
- Dividend Growth: Consider not just the current yield, but the company's history of dividend increases.
- Yield Traps: Be cautious of extremely high yields, which might indicate a falling stock price or unsustainable payout.
- Total Return: Remember that dividend yield is just one component of total return. Consider potential for capital appreciation as well.
- Company Life Cycle: Mature companies often pay higher dividends, while growth companies may reinvest profits instead of paying dividends.