As an investor, there are a few key metrics you can use to determine how well an investment is paying off and how much cash flow you’re getting from it.
One of those metrics is the dividend yield, which allows investors to see how much a particular company pays out in dividends relative to its stock price. Of course, dividends aren’t the only way to make money with stock investing. But if you’re looking for dividend income opportunities or comparing companies to invest in, it can be a helpful metric.
Are you wondering how you can use dividend yield as an investor? In this guide, we’ll cover what dividend yield really means, how to calculate it, why it’s important, and more.
Understanding Dividend Yield
To start by explaining dividend yield, we should first explain how dividends work. Dividends are distributions that companies make to their shareholders as a way of passing along some of their profits. Companies aren’t required to pay dividends — many choose not to. But dividend stocks can be an excellent investment opportunity for individuals who want to add an additional recurring income source to their portfolios.
Dividend yield is a financial metric ratio that measures the amount a company pays its investors in dividends over the course of a year in relation to its stock price. The dividend yield is represented as a percentage rather than a dollar amount. You can find the dividend yield of a stock by dividing its annual dividend by the share price.
A company’s dividend yield can change over time, especially if the company’s stock price is experiencing volatility. As a result, it’s not always an accurate metric to rely on when deciding whether to invest in a dividend-paying company. Instead, it can be one metric to use alongside others when making investment decisions.
How to Calculate Dividend Yield Formula
As we mentioned, dividend yield is expressed as a percentage and shows how much you can expect to make in dividends in a year for each dollar you invest in a particular stock. You can calculate dividend yield by dividing a company’s annual dividend by its current share price:
Dividend Yield = Annual Dividends Per Share / Price Per Share
Suppose a company had a current stock price of $25 per share and paid annual dividends of $1 per share. To calculate the company’s dividend yield, you would divide its annual dividend by its price per share ($1 ÷ $25). The result is a dividend yield of 4%.
If you aren’t sure how to find out this information for a company, don’t worry — it’s easy to find. A company’s annual dividends are usually shared in its annual report. You can also use your most recent dividend payment if you’re a current investor. If you aren’t already a shareholder of the company, you can generally find this information on any stock news or analysis website.
Why Is Dividend Yield Important?
Dividend yield can be a helpful financial metric for both current and prospective investors. It shows the amount of dividend you would earn per year for each dollar you had invested in the company. However, dividend yield — especially changes in the dividend yield over time — can tell you one of several different things.
First, it’s clear that dividend yield can help you see how much you might earn in dividends by investing in a particular company. It’s especially helpful when comparing multiple companies. You can easily see which would provide the greatest amount of dividends for each dollar you invested.
However, dividend yield can also tell you other things. For example, a dividend yield that’s rising over time could indicate the company has increased its dividend payments. On the other hand, it could also indicate a company’s stock price is falling. A falling dividend yield could either indicate reduced dividend payments or an increased stock price.
Like other financial metrics, dividend yield is just one helpful tool for investors, but it doesn’t necessarily give you all the information. It’s most helpful when used in conjunction with other metrics and information.
Pros and Cons of Dividend Investing
There are quite a few advantages to dividend stocks for investors. However, there are also some downsides to consider.
- Dividend reinvestment for compounding returns: Rather than receiving your dividends as income, you can choose to reinvest them in your portfolio, which helps your investment growth to compound even more quickly.
- Passive dividend income stream: Dividends can serve as an entirely passive income stream. Once you purchase a dividend stock, you’ll receive regular dividend payments without having to do anything else.
- Hedge against inflation: The best hedge against inflation is an investment whose growth exceeds the inflation rate. Dividends can help increase the amount you earn from your investments, providing an additional hedge against inflation.
- Solid total investment returns: Capital gains aren’t the only way to earn a return on your investments. Dividend stocks help diversify your portfolio and your income streams to increase your overall investment returns.
- Preferential tax treatment: Dividend payments can be either qualified or ordinary dividends. Qualified dividends have a preferential tax treatment and are taxed at the lower capital gains tax rate rather than your income tax rate.
- Tax inefficiency: As we mentioned, different dividends have a different tax treatment. Ordinary dividends are taxed as ordinary income, which is higher than the rate for capital gains taxes for most investors.
- Investment research: If you choose to build a dividend portfolio, it will require a bit more research than simply investing in an S&P 500 or total stock market index fund. You’ll have to research and seek out companies that consistently pay dividends.
- Investment risk: Any time you invest, you’re taking on some level of risk. While dividend stocks provide an added benefit of recurring income, they also each have their own risks that you must also consider.
- Dividend policy changes: Companies aren’t required to pay dividends. You could decide to invest in a company because of its high dividend yield, only to have it reduce dividends the following year.
- Sector concentration: Certain types of companies — and certain sectors — tend to pay dividends at higher rates. Focusing on only those companies in your portfolio could provide a lack of diversification and too heavy a concentration on one sector.
Key Considerations and FAQs for Dividend Yields
What’s the Difference Between Dividend Yield vs. Dividend Payout Ratio?
The dividend yield and dividend payout ratio are both measures of a company’s dividends. While the dividend yield measures annual dividends per share relative to a company’s share price, the dividend payout ratio measures total annual dividends relative to the company’s net income.
Are Dividend Stocks Worth It?
Dividend stocks can definitely be worth it, thanks to the additional income they provide. However, they may come with other tradeoffs, such as being concentrated in certain industries or certain types of companies. Whether they’re worth it for you depends on your investment goals and strategy.
Are Dividend Yields Higher When the Stock Market is Low?
When a company’s stock price falls, its dividend yield increases in comparison, since the stock price is a key figure in measuring dividend yield. However, if the company’s stock price remains low, its dividend yield may eventually fall as well.
How Much Investment Is Required To Get Dividends?
There’s not necessarily a set dollar amount needed to earn dividends. The dividend yield can be a helpful tool in discovering how much you’d have to invest in a particular company to earn your desired level of dividends.
What is the Ex-Dividend Date?
The ex-dividend date is the date by which you must be an investor in a company to receive its upcoming dividend. If you buy a stock on or after the ex-dividend date, the seller, not you, will receive the dividend.
Can You Lose Money With Dividend Stocks?
You can lose money with any type of stock, regardless of whether it pays dividends. Even if a company pays dividends regularly, it could still experience a market event that causes its stock price to fall. However, dividend payments can help ease the pain of a market downturn.
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