# What is Dividend Yield?

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Definition:

The dividend yield is a ratio, expressed as a percentage, that compares a company’s annual dividend (the total dividends a company paid during the most recent fiscal year) to its share price.

## 🤔 Understanding dividend yield

Dividend yield is a tool for comparing the size of a company’s dividend to its share price. It’s the annual dividend divided by the stock price, where the annual dividend can either be the total dividends paid during the most recent fiscal year, the most recent dividend times four (reflecting four financial quarters), or the total dividends paid over the last four quarters per share. A high dividend yield can mean that a stock hands over a pretty penny to investors, relative to its share price. However, a higher dividend doesn’t always signal a high potential investment. Dividend yields typically change most in response to fluctuations in a company’s stock price, not based on its dividend value. For example, a company whose stock suddenly drops in price could have a very high dividend yield, or a company whose stock value quickly soars could have a low dividend yield. This helps show why it’s important to use dividend yield as just one tool in evaluating a potential investment.

Example

Let’s consider Disney’s dividend yield, as of July 12, 2019. Dividend yield is a percentage found by dividing a company’s total annual dividend by its share price. Disney’s share price = \$144.88 (as of July 12, 2019) Disney’s semi-annual dividend: 88 cents (pay dates (when investors get their change) on January 10, 2019 and July 25, 2019) Disney’s dividend yield: 1.21% (as of July 12, 2019)

Source: Share price (Yahoo Finance). Dividend information (Walt Disney Corporation website). FYI, this example is just for illustrative purposes. There’s no guarantee or assurance that companies will declare dividends in the future or that if declared, they will remain at current levels or increase over time.

## Takeaway

Dividend yield is like a stock’s bang for your buck…

It’s a ratio comparing the income an investor gets from holding a stock (that pays dividends) to the price of that stock. Shown as a percentage, it’s calculated by dividing the annual dividend (the amount a stock pays investors through a year’s worth of dividends), by the stock’s price. Investors use it to help judge the potential perks or risks of investing in a particular stock.

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## How’d we do the math in our “Example” to find Disney’s dividend yield?

Dividend yield is a percentage found by dividing a company’s total annual dividend by its share price. To calculate Disney’s dividend yield, we need to calculate its total annual dividend and then divided this by its stock price at a particular point in time.

Disney’s total annual dividend can be found a few different ways:

1. By taking Disney’s most recent dividend and multiplying it by two (because Disney pays two dividends per year) to find its annual dividend. (Note: Many dividend-paying companies pay four dividends per year, for each financial quarter. For these companies, we’d multiply their most recent dividend by four to find their annual dividend)
2. By adding up Disney’s two most recent semi-annual dividends. (Note: For companies that pay four dividends per year, we’d add up that company’s four most recent dividend payments)
3. By adding up the two dividends in Disney’s most recently completed financial year (aka fiscal) year. (Note: For companies that pay four dividends per year, we’d add up the four dividends paid in that company’s most recent complete fiscal year)

For this example, we’ll add up Disney’s two most recent dividend payments (the dividends it pays on a semi-annual basis) to calculate its annual dividend, and its closing share price on July 12, 2019 for its share price.

Doing the math: Disney’s annual dividend = The sum of the two dividends Disney pays per year: 88 cents paid on both January 10, 2019 and July 25, 2019 (aka, the pay date, when investors get their change)

= \$1.76 in annual dividends

Disney’s July 12, 2019 share price = \$144.88

\$1.76 in annual dividends divided by \$144.88 share price

= a 1.21% divided yield

## What’s the difference between dividend yield and total return?

The dividend yield is one component in the total return equation, which is a way of quantifying the overall monetary benefit or downside of investing in a stock. The total return is the sum of the dividend yield (if the stock doles out dividends) plus the percentage change in a stock’s price.

The equation?

Total return % (over specific time period) = Dividend yield % + Price change % over that period.

For example, if a stock pays a 2% dividend yield and its stock increases by 5% this year, it would have a total return of 7%.

The total return can also be negative. If a stock pays a 3% dividend but had a stock decrease of 9%, it would have a -6% total return.

The total return can change often and significantly based on the company’s stock price. It could also change, for example, in response to substantial changes to that company’s dividends, which would affect the dividend yield.

FYI, we put this together for illustrative purposes only and doesn’t reflect the actual returns of any investment.

## What’s the difference between dividend yield and payout ratio?

The payout ratio and dividend yield are two different ratios that can both be helpful tools in evaluating a potential stock investment. The payout ratio shows what percentage of a company’s profits that company spends on dividends (it’s calculated by dividing the annual dividends per share by the company’s earnings per share). Meanwhile, the dividend yield is the value of a stock’s dividend divided by its stock price.

## What are the limitations of dividend yields?

A high dividend yield doesn’t always correlate with a strong investment. The dividend yield is dependent on both the value of the company’s dividend, as well as its stock price, which could change unexpectedly and dramatically. As a result, a dividend yield could become suddenly larger (if the stock drops) or smaller (if the stock soars). However, in those instances, a high dividend yield may not correlate with a positive trajectory for the company, and a low dividend yield may not correlate with a negative trajectory for the company. A company’s dividend yield can also become less accurate to calculate as more time passes from a company’s most recent dividend payment or dividend announcement (company plans to cut a dividend yield, for example, can inform how an investor views the relevance of his or her most recent dividend yield calculation.)

This helps show why it’s important to consider many metrics and signals when evaluating a potential stock investment. Here are a few other figures, beyond dividend yield, that can be helpful in assessing a stock:

1. History of the company’s profit and revenue growth.
2. History of the company’s dividend (if it offers one) — Has it increased over time? Is it sustainable?
3. The company’s debt and debt history.
4. A company’s credit rating (aka, the creditworthiness of a company.

## Which types of companies tend to have high dividend yields?

It’s important to calculate dividend yield on a company-by-company basis to understand how one dividend-paying stock compares to another. However, there are some patterns in the characteristics of companies that tend to have high or low dividends. Here are three common patterns among companies with high dividend yields:

1. Maturity: Companies that are more established and stable tend to have higher dividend yields. These are often consumer companies that see a steady demand from consumers that isn’t affected by seasonal changes.
2. Certain sectors: Think staple items and services. Examples of these types of companies are those that sell products that people use widely and often, and are reluctant to cut from their budgets, even under personal financial stress or amid a weak economy. Examples of these products are consumer packaged goods like food, beverages, or hygiene products, as well as items like tobacco or alcohol. Utility companies are another example of services that tend to have consistent demand and high dividend yields.
3. Companies with income regulations: Some companies like REITs (real estate investment trusts), business development companies, and master limited partnerships (a business that operates as a publicly traded limited partnership, meaning one or more of the partners is liable only up to the value of their investment), are usually set up in a way that the US Treasury requires them to pass on most of their income to shareholders. As part of this requirement, (the company doesn’t have to pay taxes on income they send to shareholders as dividends, but the shareholder must account for this gain in his or her taxes as “ordinary” income). Because these companies have such high dividends, they tend to have high dividend yields as a result.

A note on tech stocks: Many tech companies don’t offer dividends at all. Among those that do, the general rule still applies that the more mature the company, the higher its dividend yield tends to be.

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