Whether you’re a seasoned investor or are just getting started, chances are you come across one investing term more often than others: dividend yield.
While defining “ In this post, we’ll explain what dividend yield means, why it matters, and show you how to use the dividend yield formula. Use the links below to navigate ahead, or read end to end for a more detailed overview of the topic.
- What is Dividend Yield?
- Dividend Yield Formula
- Important Notes on Dividend Yields
- Wrapping Up
What is Dividend Yield?
Before we define and learn how to calculate dividend yield, let’s make sure we’re all on the same page about dividends. Dividends are payments that companies make out to their shareholders for owning stock in their organization. Dividends can be earned from stock across a myriad of industries, including, real estate investments and consumer staples. Dividends are typically based on the company’s profit and performance throughout the year, and are generally paid out quarterly.
Definition of Dividend Yield
Dividend yield is the metric that can be used to help dividend investors anticipate how much a company pays out to shareholders in the form of dividends on an annual basis, compared to the current price of their shares.
Why does it matter? By comparing a company’s annual dividend share with the individual cost per share, investors can estimate their profit margins, and thereby, make more informed investment decisions.
Although calculating dividend yield can arm investors with essential information, it’s important to note that historical trends don’t always indicate future performance. In addition to finding a stock’s dividend yield, you may also want to consider some other variables and sources before making any investment decision—more on that a little later on.
How to Find Dividend Yield
To find dividend yield, you’ll need to start by identifying two important figures first: annual dividend per share and current share price. These numbers can both be found on the major stock market indexes. Note: to find the most accurate predictions, you’ll want to use the most updated data available.
Now that you have these details, you can calculate dividend yield using the dividend yield formula.
Dividend Yield Formula
To find the dividend yield, you must divide the dollar value of the annual dividend by the current share price.
Dividend Yield = Annual Dividend Per Share ($) ÷ Share Price ($)
Once you’ve divided the annual dividend per share by the share price, multiply the number by 100 to find the dividend yield percentage.
Dividend Yield Formula Example
To better understand how the dividend formula works, let’s take a look at a fictional example.
So if you buy shares today at $40 per share, you can estimate that you’ll earn 2.5% per year from dividends (before tax).
There are a few things to consider once you’ve calculated dividend yield:
- If you reinvest your dividends, you get 2.5% compounded. For example, if you had enough shares invested and received $25 in dividends, you could reinvest these dividends to buy 62.5% of an additional share of stock, and that portion of stock next quarter will then also pay you a dividend. You can increase the dividends you will earn each quarter by reinvesting them (assuming the dividend rate and share price stayed the same).
- The higher the stock price goes, the lower the current yield. For example, if the stock price rises to $55 per share, that $1 per share is reduced to 1.8% ($1 ÷ $55 = 1.8%). However, you should calculate your dividend yield based on the price per share that you paid when you bought stock, and not on what it becomes later.
- By the same mathematical reasoning, when the stock price falls, the dividend yield rises. For example, if the price per share falls from $40 down to $32, the dividend yield rises to 3.125% ($1 ÷ $32 = 3.125%).
Important Notes on Dividend Yields
Now that you know how to calculate a stock’s dividend yield, let’s take a closer look at how this metric can be applied to buying, selling, and strategizing for your investment portfolio.
Making the most of your dividends
Anyone who tries to time the purchase or sale of stock to maximize dividend income should be aware of how the dividend distribution dates are figured. The ex-dividend date is the date on which stockholders earn their respective dividends. However, investors should note that those dividends are not paid out until several weeks later. So before you buy or sell shares with the intention of earning dividend income, find out when the ex-date occurs. If you buy after that date (or sell before), you will not earn the quarterly dividend.
Using the dividend yield formula to evaluate investments
The dividend yield should be a part of your evaluation of your portfolio and in the selection of companies whose stock you are thinking of buying if you are using a dividend investment strategy. Some companies pay exceptionally high dividends and yet are considered very safe investments. This is not always the case, so if you just pursue the highest possible yield, it makes sense to perform a few fundamental tests first, and to determine whether or not it is safe to buy shares.
Never pick a stock based solely on dividend yield. But when all else is comparable, a higher dividend can work as a means for reducing your list of prospects.
In addition to calculating a stock’s dividend yield, here are some other things you can do to empower and inform your investment decisions:
- Think about investing in the context of your personal finances first. Only you can make the appropriate financial decisions for your lifestyle and goals. Use financial tools like Mint to help you gain perspective on where your budget and financial wellness stands.
- Understand the element of risk, and assess your comfort level. All investments involve some level of risk, from stock volatility to market changes, so it’s a good idea to establish your comfortability with investment risk first. Ask yourself how much you’d be willing to lose in the hopes that you’ll actually turn a profit.
- Consider your options. If you’re not comfortable plunging into the stock market just yet, you might look for other ways to start growing your wealth. High-yield savings accounts and retirement plans offer less-risky options to boost your bucks.
- Do your research. Publicly traded companies are required to provide consumers with important financial information so that those wanting to invest can make informed fiscal decisions. By looking to gov, Investor.gov, and other reputable sources, you can arm yourself with the knowledge to make the right decisions based on your goals.
Calculating dividend yield can provide some useful insight for investors looking to earn dividend income. To find this metric, simply divide the annual annual dividend per share by the current share price, then multiply by 100.
Investors should keep in mind that dividend yield is just one piece of the puzzle when it comes to vetting investment opportunities. Doing extra research, reviewing historical trends, and considering your own financial goals will help you make the best decision for your financial health.
Need help tailoring your investment strategy? Head over to our investment calculator to start crunching the numbers!
Michael C. Thomsett is author of over 60 books, including Winning with Stocks and Annual Reports 101 (both published by Amacom Books), and Getting Started in Stock Investing and Trading (John Wiley and Sons, scheduled for release in Fall, 2010). He lives in Nashville, Tennessee and writes full time.
Investing 101: How to Calculate Dividend Yield was provided by Minyanville.com.