Definition and Examples of Dividend Yield
Dividend yield is the ratio of the dollar value of dividends paid by a company to its stock price. It is represented as a percentage. Using simple mathematics, you can calculate the dividend yield for stocks. You can even get the yield for your entire portfolio. It can be a useful tool when considering new investments. It can also help you plan for retirement. However, dividend yield often does not show the full picture. It should not be the only factor when investing.
How to Calculate Dividend Yield
For stocks, the formula to calculate dividend yield is the total annual dividends paid divided by the price of the stock. Then multiply the result by 100 to convert it to a percentage.
Let’s assume the company pays a dividend of 25 cents each quarter. Then the total annual dividends paid would be 25 cents × 4 quarters = $1. If the stock price is $100, the dividend yield would be: $1 / $100 = 0.01. Then multiply the result by 100 to convert it to a percentage, and the dividend yield would be 1%.
When the stock price is $50 and the dividend is $1 per share, the dividend yield is 2%. When the stock price drops to $40, the dividend yield changes to 2.5%. If it rises to $60, the dividend yield becomes 1.7%.
When considering the dividend yield for a whole portfolio, you can adjust your numbers to see what you are facing. It is best to run different scenarios using online calculators. Or you can discuss it with your financial advisor. This is wise if you are playing with these numbers as part of your retirement planning.
Why Does Dividend Yield Matter?
Dividend yield matters because it shows you how much income you can expect to earn. If you are planning for retirement, it is best to have an idea of how much money you will need. You will also need to know which assets can provide that for you.
Let’s look at this from two perspectives.
Individual Stocks:
Suppose you own 100 shares of a stock priced at $50 with annual dividends of $1 per share. This means the dividend yield is 2%. The value of this investment is $5,000 (100 shares × $50). With a dividend yield of 2%, you can expect to receive $100 annually in payments (2% of $5,000 = $100).
However, this does not mean you can simply pick any stock that pays dividends. Not all companies that pay dividends are the same. You should consider other factors and weigh the risks before making a decision.
Note: Very high yields can indicate a problem. Remember, as the stock price decreases, the dividend yield tends to increase. The company may not be able to keep up with paying dividends forever.
One way to assess the strength of a dividend is to look at the payout ratio. The payout ratio is a formula that expresses the percentage of a company’s net income that is paid out as dividends. Ideally, you want the payout ratio to be around 40% to 60%. Anything higher (or lower) warrants a deeper review.
One of the tried-and-true ways to select dividend-paying stocks is related to yield – earnings growth. Simply put, does the company have a long history of increasing its dividends annually? You can find the best companies in the dividend growth category. These are companies with a track record of 25 years or more of increasing dividends.
Even
Here, proceed with caution. History is full of strong companies with a track record of paying dividends that have faced troubles.
For instance, General Electric (GE) had a long history of paying dividends before the Great Recession, but in 2009, it had to cut its dividend from 31 cents to 10 cents. This was the first reduction in dividends since 1938 and a sign of tougher times ahead. In 2009, before cutting its dividend, GE had a yield of 10.6%.
Since then, GE has experienced a decline in its stock price. It has had to divest businesses and reduce jobs. The company was a founding member of the Dow Jones Industrial Average in 1896 and a stable part of the index since 1907, but it lost its place in the index in 2018. In 2019, the company cut its quarterly dividend payments to 1 cent. Its stock price was $11.08 in December 2019. This means that the yield was about 0.3% – much lower than it was 10 years ago.
Your Overall Portfolio
Do you hope to live off the income from your overall portfolio of dividend-paying stocks? If so, you should know two key things.
First, determine how much money you need to live. Let’s say it’s $40,000 annually. From here, comes the second factor. What is the size of the nest egg you’ll need, given the yield on your portfolio?
For example, suppose you have $500,000 invested. In this case, you would need your portfolio to achieve an 8% yield to provide you with $40,000 in annual income. It’s not impossible, but it is a slightly ambitious goal. A portfolio worth $1,000,000 earning $40,000 annually has a yield of 4%.
Market Yield vs. Cost Basis Yield
Understand the difference between market yield and cost basis yield. This can help you analyze the performance of your dividend-paying stock portfolio. These terms may seem intimidating, but they really aren’t.
The market yield is simply the yield based on the current stock price of the stock.
To get the cost basis yield, look at what you paid for the stock when you added it to your portfolio. Take the annual dividends of the stock. Divide it by the original stock price instead of the current stock price.
When the annual dividend payment for the stock is $4, and the current stock price is $100, the market yield is 4%. If the same stock cost $90 when you added it to your portfolio, then the cost basis yield is 4.4%.
Note: By knowing the cost basis yield, you are doing two things. You are factoring in earnings growth without punishing the company for an increase in its stock price.
As the company’s stock price rises, the yield decreases. The cost basis yield accounts for this. You are using the cost of the asset in the calculation. You are also looking at earnings growth. This earnings growth can offset a decline in yield due to the increase in the company’s stock price.
Conclusion
There are many factors that affect investment strategies. It is best to consult a financial advisor to understand your needs. However, yield can help you understand the income you can expect now and in the future.
Frequently Asked Questions (FAQs)
What is trailing yield?
When looking at yield, you may encounter the term “trailing yield” or its counterpart “forward yield.” The trailing yield measures the yield over the past 12 months, while the forward yield projects the company’s earnings yield over the next 12 months.
How
Can I find high-yield dividend stocks?
You can research stocks before buying them to identify stocks that pay dividends and how these dividends compare. However, make sure you’re also looking at other important factors in addition to the dividend yield. Look at the payout ratio, earnings per share, and price-to-earnings ratio to make smart investment decisions.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Fidelity Investments. “Payout Ratio: The Most Influential Management Decision a Company Can Make?” Page 4.
General Electric. “Investor Relations” Historical Dividends.
S&P Global. “Walgreens Boots Alliance Set to Join Dow Jones Industrial Average.”
Source: https://www.thebalancemoney.com/how-to-calculate-dividend-yield-357175
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