OVERVIEW
The yield is considered as one of the simplest but most effective ratios applied by investors to determine what dollar inflow, they expect is achievable from an investment in a particular strengthening that is any equity security. This is a relative evaluation of a firm’s capability of earning profits, as well as its attempt at returning some of the revenues to its shareholders in the form of dividends.
A dividend is in fact a portion of profits distributed to the shareholders of the company or is simply a payment to pension shareholders consequent on profits. Dividend yield helps investors compare the yearly earnings that they expect to get in terms of earnings to the initial amount of cash they used to invest. In this article, you find out what is dividend yield, having its formula and knowing its significance, the pros and cons of Dividend yield, comparing it with similar indices such as the Dividend Payout Ratio and Dividend Rate, the characteristics of investing in Dividend yield stock.
DIVIDEND YIELD FORMULA
The formula used to calculate dividends yield is quite simple and what is usually used is the dividend yield percentage. The formula to calculate the dividend yield is:
Dividend Yield = × 100
Where:
- Annual Dividend per Strip is the total dividend that the company is entitled to issue to its shareholders within one year of owning one strip.
- Stock Price per Share is the market value of the stock.
For example, if a company pays an annual dividend of $5 per share, and the stock price is $100, the dividend yield would be:
Dividend Yield = × 100 = 5%
IMPORTANCE OF DIVIDEND YIELD
Dividend yield is important for a variety of reasons:
- Income Generation: Education enthusiasts however recommend dividend yield to income-conscious investors, especially those in the retirement bracket as it acts as an extra source of income. It helps investors to know how much return they will earn per dollar invested in the stock on an every year basis.
- Investment Decision Making: Dividend yield also allows the comparison of income that particular investment can provide to the investor. More interest income could mean that the investment being made is more lucrative, though take note, such a point has to be made with caution since other factors such as the business’s position may depict otherwise.
- Stock Valuation: Relative to dividend yield it can evaluate it whether it gives good or bad indication and whether the stock price is low or high. For example, lower than average dividend yield might suggest that the company’s stock is too expensive or the business retain more of its earnings.
- Financial Health Indicator: Sustainable dividend yield therefore applies where there is evidence of sound earning and healthy balance sheet of the company. Nevertheless, there can be anomalies associated with high dividend yield; higher the dividend yields more attractive it is, but it may signal problems in the future particularly if the yield is too high.
- Risk Assessment: A stable rate of dividend means the firm’s yield is safe, especially if the company has been paying a dividend to its users for some time.
ADVANTAGES OF DIVIDEND YIELD
- Reliable Income Stream: Through dividend yield, investors get opportunity to receive predictable and consistent cash flows. This cash can be reinvested into the company or provide the investors with what they need or would like to achieve through investment.
- Attractive for Conservative Investors: Essentially, when looking for income rather than capital gains conservative or relatively moderate risk takers may prefer higher dividend yields as safer investments.
- Inflation Hedge: In particular, from the perspective of a potential investor, dividend yield stocks are an excellent inflation hedge since dividend payments usually rise proportionally to inflation rates.
- Potential for Capital Appreciation: Dividend yield stocks are associated with income, but they can also be an avenue for capital gains if the actual company expands or when the stock’s value increases over time.
- Tax Benefits: In some jurisdiction the taxes on dividend income are less than those on capital gains thus making stocks that pay dividend more lucrative.
DRAWBACKS OF DIVIDEND YIELD
- Lower Growth Potential: High dividend paying firms may make lower investments by retaining less money in the firm thus have low growth prospects. This could be the case with companies considered to be mature or growth rate slow and therefore more inclined to actually reinforce a strategic marketing plan.
- Unstable Dividends: Despite the fact that dividend yield can provide a consistent stream of income, dividends are not fixed. Sustaining losses and they are reductions or halt in dividends during tough times possible for companies? Why investors might be affected.
- Higher Risk of Dividend Cuts: Companies with extremely high dividend yield are more likely to be subjected to dividend reduction in future, either due to poor financial performance or because the established dividend figure may no longer be sustainable.
- Impact of Market Fluctuations: The price per share may go up, as well as going down, affecting the quantity of dividend yield. Lower stock price increases the ratio of dividend yield but it may be fake if the price decline stems from problems with the company’s operations.
- Limited Capital Appreciation: The core idea is that dividend stocks may provide less capital appreciation possibility compared to those non-dividend paying stocks particularly in the high-growth industries such as technology.
DIVIDEND YIELD Vs. DIVIDEND PAYOUT RATIO
While both dividend yield and dividend payout ratio relate to dividends, they are different metrics with distinct purposes:
- Dividend Yield as a performance measurement is the amount of return obtained from investment in terms of the price paid for the stock; that is, how much more income will investors get from the Dividend compared to the stock price they have paid.
- Dividend Payout Ratio, on the other hand, established the liquidity of the proportion of a company’s earnings paid out to the shareholders. It is calculated as:
Dividend Payout Ratio = ×100
This ratio assists investors in determining the level of sustainability of a company dividend. High payout ratio could mean that the company is distributing a large portion of its profits jeopardizing future dividend payments if it hits the wall.
DIVIDEND YIELD Vs. DIVIDEND RATE
The terms “dividend yield” and “dividend rate” are often used interchangeably, but they are not the same:
- Dividend Rate is known as actual amount of dividends paid per share and the information is usually presented on an annual basis. For instance, if a firm is paying $2 on each share per every year, the dividend rate is $2.
- Dividend Yield describes the amount of dividend against the total stock price. In the case, if the price per share is $40 and dividend rate is $2, it will give the company a yield of 5%.
In this respect, while the dividend rate gives the precise figure of amount expected per share of dividend, the dividend yield factor conveys the possibility of earning the referred amount in terms of percentage of its market price.
FEATURES AND BENEFITS OF DIVIDEND YIELD STOCKS
- Stable Income: Dividend yield stocks generate fixed income and they are ideal for retired persons and anyone who want a regular income from his portfolio investments.
- Compounding Opportunity: It provides a compound growth from the dividends which is much effective in the long run so it is approved by utilizing the dividends to buy more stocks.
- Lower Volatility: It is also a fact that dividend stocks are less risky than other non-dividend-paying stocks because shareholders usually do not allow their stocks to fall significantly and investors know that they receive regular dividends.
- Diversification: Earnings yields are a key to investing- Dividend yield stocks can complement an investment portfolio. Portfolio diversification within a number of other industries affects the US investors and holding dividend stocks entails lower risks.
- Long-Term Value: To a large extent dividend yield stocks still remain the stocks that offer good long-term returns that are crucial to long-term portfolio strategy.
- Higher Investor Confidence: Every time a firm declares a dividend then it is believed to be well placed financially and therefore can positively influence the market price of the shares.
Example: A REAL-WORLD APPLICATION OF DIVIDEND YIELD
To make our understanding concrete let us examine an example of how dividend yield is used in practice. For illustration, let us assume you have invested in a company by the name XYZ Corp. which has an annual dividend of $3 per share. If the current stock price is $60, the dividend yield would be:
Dividend Yield = ×100 = 5%
This gives the connotation that for every $100 invested in XYZ Corp. you will be earning $5 in dividends per year.
But suppose the price of the stock goes up to $80 per share., Now, the annual dividend of $3 remains the same, but the dividend yield would decrease:
Dividend Yield = × 100 = 3.75%
In this case though they are getting the same sum as dividend income their yield in terms of the invested stock is lower due to an increased value in price.
CONCLUSION
Dividend yield is another important measure which people use to determine much income the invested in stock shares will generate. However, since its primary objective is to make steady income through share prices, Dividend yield stocks also have inherent disadvantage such as low capital appreciation prospect as well as threat of dividend reduction. This paper aims to offer information on the comparison of the dividend yield with other key figures such as the dividend payout ratio and the dividend rate.
Dividend yield stocks are well-favored by income-oriented investors especially those seeking ordinary income or those who want to diminish risks. However, it is often wise that more attention should be paid to the level of solvency within the company and the future predictability of dividend yield as these stocks are often focused on.
FAQs
Q1. What is Dividend Yield?
Dividend Yield is a measure of the income obtained from an investment in a stock relative to its current market price. It gives the annual dividend that can be obtained from a share of stock in terms of the percentage of the stock’s price.
Q2. What does the term Dividend Yield & Dividend Payout Ratio mean?
Dividend Yield: It is defined as the amount of annual dividend paid on a particular stock that an investor holds as a proportion of the current price of the stock. It is a sign of how many times your income would be like what you put in the stock, as an investment.
Dividend Payout Ratio: It is relative measure showing the portion of the earning of the firm that is paid to investors through dividends. It shows the level of sustainability in which a firm is paying out its earnings and whether most of what it is earning is actually being paid out in form of dividends or held for reinvestment.
Q3. What can one gain from Benefits of Dividend Yield?
The strength of dividend yield lies on the ability of particularly those investors who require periodic cash income such as retirees or those who desire a specific amount of cash inflows periodically.
- Lower Risk: It is revealed that the companies that pay the dividend are older and have better financial resources to pay the dividend, therefore lower risk compared to the high-growth, non-dividend firms.
- Inflation Hedge: Since companies usually reguarly increase their dividends, the dividend yield stock will help the investor to counter inflation.
- Reinvestment Opportunities: Withholding the dividend and investing it back into the same stock or other investment brings in the returns in succession.
- Tax Benefits: Because in some area’s dividends are taxed lower than capital gains, second dividend stock is comparatively more tax efficient.
Q4. Is Dividend Yield a Good Investment?
It can also be true that dividend yield can be a good investment if for instance a person wants an income stream in other to support a budget. Still, dividend yield stocks might not be as popular provided by total amount of financial results desired by the investor as well as perceived level of risk, he/she is willing to take.
Pros of dividend yield stocks:
- Ideal investment for income-focused investors.
- It tends to stabilize in volatile markets.
- It can act as an inflation hedge.
- Disadvantages of Dividend Yield Stocks:
- Limited capital appreciation, mainly in mature industries.
- A very high dividend yield may indicate financial distress or unsustainable dividends.
- Stock price may also decline, should the dividend be reduced.
- In general, dividend yield stocks will be more appropriate for low-risk investors, or those who cannot afford to miss a steady flow of income but risk lower returns from stocks in sectors like technology by investing in non-dividend-paying stocks.
Q5. How To Determine Dividend Yield On A Financial Statement?
- To calculate dividend yield from a financial report, follow these steps:
- Find the annual dividend per share: This can be found in the firm’s annual report under more information and then under dividends. Some companies announce their quarterly dividends so you can get the annual dividends per share by multiplying this figure by 4.
- Find the stock price: Determine the current price for the particular stock in the market. This can be retrieved on any financial news or stock price tracking website.
- Apply the Dividend Yield Formula