What Does Dividend Yield Show?

What Does Dividend Yield Show?

Capital gains are the primary reason why investors choose to buy stocks, but it certainly is not the only one. Stocks of large, well-established companies often pay dividends, which are regular cash payments made to the brokerage accounts of a company’s shareholders, who can choose to keep the money or reinvest it in exchange for more shares. 

For this reason, investors needed a metric to evaluate the returns generated by a dividend-paying stock to make forecasts and build a coherent investment strategy with predictable returns. 

Dividend yield is the main metric used to measure the absolute returns of a stock’s dividend payments over a year. 

Dividend yield is denoted as a percentage return on the capital invested in dividend-paying stocks and real estate investment trust (REITs). 

Investors use dividend yield as one of several factors when making investment decisions, particularly for income-oriented strategies. It provides insights into the income potential and relative value of dividend-paying investments.

If you are a beginner stock investor and would like to know more about how dividend yield works, this Investfox guide can help. 

Dividend Yield Calculation And Usage

Dividend yield is a fairly simple metric to calculate. Here is the formula for finding the dividend yield of any stock or REIT:

Dividend Yield = Annual Dividend Per Share / Market Price Per Share X 100%

Knowing the dividend yield of a security can help investors in a few key ways, such as:

  • It helps investors assess the income potential of an investment, especially in dividend-paying stocks or income-focused investments like bonds
  • A higher dividend yield indicates a potentially higher income relative to the investment's price
  • Dividend yield is inversely related to a stock's price. If the stock price rises while the dividend remains the same, the yield decreases, and vice versa
  • Investors often consider both the dividend yield and the stability of dividend payments when evaluating the attractiveness of income-generating investments
  • However, a high dividend yield could also indicate that the market has concerns about the company's financial health or growth prospects, leading to a lower stock price

Dividend Yield Pitfalls To Avoid

Solely relying on dividend yields can be unreliable, as there are different reasons why a stock or REIT may have an exceptionally high dividend yield. 

For example, a distressed stock with a declining price is likely to have a high dividend yield. However, investing in such a stock may not be profitable in the long run, as the declining price can eat into the gains generated through dividend payments. 

Furthermore, REITs typically have higher dividend yields than most stocks, as REITs are mandated to distribute at least 90% of their net income as dividends. It may not be entirely evident whether a public company is a REIT or not, which is why it is important to research prospective stocks before investing. 

Analyzing the financial stability of prospective stocks is crucial, as dividend yield alone cannot show the full picture of the company. 

Key Takeaways From What Does DIvidend Yield Show

  • Dividend yield is an important metric that shows the annual returns generated by investing in dividend-paying assets, such as stocks and REITs
  • Dividend yield is a percentage return that is calculated by dividing the annual dividend per share by the current market price per share and multiplied by 100%
  • REITs tend to have higher dividend yields, due to the rules that mandate that at least 90% of their net earnings be distributed as dividends 
  • Dividend yield alone might not be a reliable indicator of the viability of an investment, as stocks with declining prices can have high dividend yields

FAQs On Dividend Yield

What is dividend yield?

Dividend yield is a financial ratio that represents the annual dividend income an investor can expect to receive from a stock, expressed as a percentage of the stock's current market price. It helps investors assess the income potential of a dividend-paying investment.

Why do REITs have a high dividend yield?

Real Estate Investment Trusts (REITs) often have high dividend yields because they are required by law to distribute at least 90% of their taxable income to shareholders. Their primary income source is rental income from real estate properties, which generates consistent cash flows for dividend payments.

How is dividend yield calculated?

To calculate dividend yield, divide the annual dividend payment per share by the current market price per share and then multiply by 100 to express it as a percentage. The formula is: Dividend Yield = (Annual Dividend per Share / Current Market Price per Share) x 100%.