Table of Contents
- How to Calculate Dividend Yield
- Dividend Yield vs Dividend Rate vs Dividend Payout Ratio
- Is it Better to Have a High or Low Dividend Yield?
- Why is Dividend Yield Important?
Dividend yield is a measure used to calculate the amount a company pays out in dividends relative to the price of its stock. The value obtained represents the approximate dividend-only return that a stock provides.
Since the calculation of the dividend yield involves both the amount paid out in dividends per year, as well as the share price, a drop in the share price may increase the yield, while a rise in the share price would decrease the yield. As a result, investors should consider other factors besides the dividend yield when evaluating a company, as a stock that has recently fallen in value may have an unusually high dividend yield.
How to Calculate Dividend Yield
The dividend yield is calculated by dividing the annual dividends per share by the price per share, expressed as a percentage.
The dividend yield may be manually calculated by retrieving dividend amounts from the company’s last annual report or website, or from various online sources which calculate the yields automatically. Some dividends are paid out on a quarterly or half-yearly basis, so investors should ensure that they include the entire year’s dividend payments when calculating the dividend yield.
Dividend Yield vs Dividend Rate vs Dividend Payout Ratio
A company’s dividend rate refers to the absolute monetary amount an investor receives as a dividend in a given financial year. A dividend yield uses the dividend rate in its calculation, but also factors in the price per share and is expressed as a percentage rather than an absolute amount.
The dividend payout ratio calculates the total annual dividend payout as a proportion of the company’s net income generated in a given year. The dividend payout ratio is normally seen as a more reliable measure of whether a company can provide consistent dividend distributions than the dividend yield, as the latter does not take into account the company’s net income.
Is it Better to Have a High or Low Dividend Yield?
In general, investors seeking higher yield investments may lean towards companies with a high dividend yield. However, it is important to consider other factors that may affect an investor’s returns. It would be prudent to go through the financial and dividend history of the company and assess whether dividends have increased, decreased, or maintained steady. Investors should be forward looking as well and analyse whether the company has the income generation potential, or sufficient cash reserves, to continue these dividend payouts in the future.
It is also worth noting that if a company is consistently distributing a large amount of dividends, it implies that the money is not being reinvested into the company’s growth. While this might not have a major impact on companies that have huge cash reserves, investors should be wary if companies are distributing large dividends despite lackluster business performance, or if they do not have sufficient cash reserves and are taking on additional debt or equity just to fund or maintain high dividend payouts.
Why is Dividend Yield Important?
Some investors, especially retirees, may rely on dividend payments from the shares they hold as a primary source of income. For such investors, the dividend yield is essential to the management of their personal finances. For a company’s shareholders, the dividend yield is an important barometer of how a company is doing financially, and a company’s dividend policy also gives an indication of management’s stance on utilising cash reserves.
Read also: What Does a Financial Advisor Do?
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