What is Dividend Yield?

Fundamentals · Jul 8, 2019

When it comes to measuring dividend return of a particular stock, it’s important to understand what dividend yield is. It’s a rather simple concept but it may confuse some people because they’re expecting to see an absolute number, instead, they usually see some weird “yield” thing in the form of a fraction.

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‘Yield’ is a strange word with several meanings: it can mean ‘to produce something’, or ‘to back up’, or ‘to let someone or something go first’.

What Does ‘Yield’ Mean in Finance?

In finance and business, the word ‘yield’ has pretty much the same meaning as the return. It shows how much money you would get back on your investment after a certain period of time, often after one year. If the yield of $1000 investment is equal to 10%, you would get back 1/10 ($100) of your investment every year.

A dividend yield of 5% means that you need 20 time periods to return 100% of your investments (100/5=20), 10% would mean that you need 10 years, and 1% yield indicates that you would need to wait 100 years to double up your money, assuming the stock price won’t change.

In this sense, the concept of dividend yield is somewhat similar to the payback period in business.

How to Calculate Dividend Yield?

To calculate a dividend yield you can use this simple formula:

$$ Y = \frac{D}{P} $$

Where:

  • Y: Dividend Yield
  • D: Annual Dividend Paid Per Share
  • P: Share Price

For instance, if a company pays $5,000,000 in dividends every year and there are 5,000,000 outstanding common shares (for preferred shares the dividend yield may differ), the annual dividends (D) would be $1 per share. Then you just have to know the current price of those shares, suppose it’s $10 per share, therefore the last step is to divide $1 by $10 to get 0.1. This is a percentage and 0.1 means 10% yield.

Understanding Dividend Yield

So you’ve got 10%, or maybe 4%, or any other number.

What does it mean exactly? Is it high or low?

Well, first of all, we have to understand that some of the publicly traded companies don’t pay any dividends at all because their business might be in aggressive growth stage or they might give back to their investors in a more tax-efficient way such as via the share buyback policies.

The yields of the companies that actually pay dividends vary quite a lot, but usually, it’s somewhere between 1 and 10%. A yield of 5% is often considered as OK, it’s actually a quite good one. If it’s 8%, 11% or higher, it’s a little bit suspicious and this company has to be inspected because it’s expensive for a company to pay a lot of dividends. Inadequately high dividends might be a trick to lure more investors money easily and then to run away overseas.

Additionally, a price volatility of a particular stock could be high during an active bear or bull trend and this would have a major impact on the dividend yield because one side of its formula is all about the current price. At the same time, the dividend amount is something that usually changes only once a year, therefore the yield may change by a lot with any market fluctuations.

To understand the concept of yield, you may think of it as a return on any other investment and this is the reason why this concept of ‘yield’ was introduced in the first place: to make it comparable with things like return on real estate or return on a banking deposit. Even a 5% dividend yield in American dollars is quite a decent income and you can barely get the same returns with banking products or even bonds, but the dividend has a downside of being more volatile.

Companies that pay a lot of dividends are popular among conservative investors, but it doesn’t mean that they are completely risk-free.

Real Examples of Dividend Yield

Here are some real dividend yields on the market (source: nasdaq.com):

  • Vanguard Whitehall Funds (VYMI): 6.6%
  • Credit Suisse AG (GLDI): 4.7%
  • PepsiCo, Inc. (PEP): 2.8%
  • Intel Corporation (INTC): 2.6%
  • Lockheed Martin: 2.4%
  • McDonald’s: 2.3%

The majority of trusted companies with a long history have a dividend yield below 3%, with just a few exceptions. The corporations that pay a higher yield are usually riskier or they belong to the investment/financial sector. Many companies prefer to keep their dividend yield just above the GDP growth rate, inflation and the returns of the U.S. treasury bonds.

Diversification   Investing   Finance   Portfolio   Personal finance   Dividends   Income   Stocks

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