Dividend Yield: Meaning, Formula, Example, and Pros and Cons (2024)

What Is the Dividend Yield?

The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price.

The reciprocal of the dividend yield is the total dividends paid/net income which is the dividend payout ratio.

Key Takeaways

  • The dividend yield—displayed as a percentage—is the amount of money a company pays shareholders for owning a share of its stock divided by its current stock price.
  • Mature companies are the most likely to pay dividends.
  • Companies in the utility and consumer staple industries often have relatively higher dividend yields.
  • Real estate investment trusts (REITs), master limited partnerships (MLPs), and business development companies (BDCs) pay higher than average dividends; however, the dividends from these companies are taxed at a higher rate.
  • It's important for investors to keep in mind that higher dividend yields do not always indicate attractive investment opportunities because the dividend yield of a stock may be elevated as a result of a declining stock price.

Dividend Yield: Meaning, Formula, Example, and Pros and Cons (1)

Understanding the Dividend Yield

The dividend yield is an estimate of the dividend-only return of a stock investment. Assuming the dividend is not raised or lowered, the yield will rise when the price of the stock falls. And conversely, it will fall when the price of the stock rises. Because dividend yields change relative to the stock price, it can often look unusually high for stocks that are falling in value quickly.

New companies that are relatively small, but still growing quickly, may pay a lower average dividend than mature companies in the same sectors. In general, mature companies that aren't growing very quickly pay the highest dividend yields. Consumer non-cyclical stocks that market staple items or utilities are examples of entire sectors that pay the highest average yield.

Although the dividend yield among technology stocks is lower than average, the same general rule that applies to mature companies also applies to the technology sector. For example, as of June 2023, Qualcomm Incorporated (QCOM), an established telecommunications equipment manufacturer, had a trailing twelve months (TTM) dividend of $3.20. Using its current price of $140.20 as of January 12, 2024, its dividend yield would be 2.30%. Meanwhile, Block, Inc. (SQ), a somewhat newer mobile payments processor, pays no dividends at all.

REITs, MLPs, and BDCs

In some cases, the dividend yield may not provide that much information about what kind of dividend the company pays. For example, the average dividend yield in the market is very high amongst real estate investment trusts (REITs). However, those are the yields from ordinary dividends, which are different than qualified dividends in that the former is taxed as regular income while the latter is taxed as capital gains.

Along with REITs, master limited partnerships (MLPs) and business development companies (BDCs) typically have very high dividend yields. The structure of these companies is such that the U.S. Treasury requires them to pass on the majority of their income to their shareholders. This is referred to as a "pass-through" process, and it means that the company doesn't have to pay income taxes on profits that it distributes as dividends. However, the shareholder has to treat the dividend payments as ordinary income and pay taxes on them. Dividends from these types of companies (MLPs and BDCs) do not qualify for capital gains tax treatment.

While the higher tax liability on dividends from ordinary companies lowers the effective yield the investor has earned, even when adjusted for taxes, REITs, MLPs, and BDCs still pay dividends with a higher-than-average yield.

Calculating the Dividend Yield

The formula for dividend yield is as follows:

DividendYield=AnnualDividendsPerSharePricePerShare\begin{aligned}&\text{Dividend Yield} = \frac{ \text{Annual Dividends Per Share} }{ \text{Price Per Share} } \\\end{aligned}DividendYield=PricePerShareAnnualDividendsPerShare

The dividend yield can be calculated from the last full year's financial report. This is acceptable during the first few months after the company has released its annual report; however, the longer it has been since the annual report, the less relevant that data is for investors. Alternatively, investors can also add the last four quarters of dividends, which captures the trailing 12 months of dividend data. Using a trailing dividend number is acceptable, but it can make the yield too high or too low if the dividend has recently been cut or raised.

Because dividends are paid quarterly, many investors will take the last quarterly dividend, multiply it by four, and use the product as the annual dividend for the yield calculation. This approach will reflect any recent changes in the dividend, but not all companies pay an even quarterly dividend. Some firms, especially outside the U.S., pay a small quarterly dividend with a large annual dividend. If the dividend calculation is performed after the large dividend distribution, it will give an inflated yield.

Finally, some companies pay a dividend more frequently than quarterly. A monthly dividend could result in a dividend yield calculation that is too low. When deciding how to calculate the dividend yield, an investor should look at the history of dividend payments to decide which method will give the most accurate results.

Advantages of Dividend Yields

Historical evidence suggests that a focus on dividends may amplify returns rather than slow them down. For example, according to analysts at Hartford Funds, since 1960, 69% of the total returns from the are from dividends. This assumption is based on the fact that investors are likely to reinvest their dividends back into the S&P 500, which then compounds their ability to earn more dividends in the future.

For example, suppose an investor buys $10,000 worth of a stock with a dividend yield of 4% at a rate of a $100 share price. This investor owns 100 shares that all pay a dividend of $4 per share (100 x $4 = $400 total). Assume that the investor uses the $400 in dividends to purchase four more shares. The price would be adjusted on the ex-dividend date by $4 per share to $96 per share. Reinvesting would purchase 4.16 shares; dividend reinvestment programs allow for fractional share purchases. If nothing else changes, the next year the investor will have 104.16 shares worth $10,416. This amount can be reinvested into more shares once a dividend is declared, thus compounding gains similar to a savings account.

Disadvantagesof Dividend Yields

While high dividend yields are attractive, it's possible they may be at the expense of the potential growth of the company. It can be assumed that every dollar a company is paying in dividends to its shareholders is a dollar that the company is not reinvesting to grow and generate more capital gains. Even without earning any dividends, shareholders have the potential to earn higher returns if the value of their stock increases while they hold it as a result of company growth.

It's not recommended that investors evaluate a stock based on its dividend yield alone. Dividend data can be old or based on erroneous information. Many companies have a very high yield as their stock is falling. If a company's stock experiences enough of a decline, it may reduce the amount of the dividend, or eliminate it altogether.

Investors should exercise caution when evaluating a company that looks distressed and has a higher-than-average dividend yield. Because the stock's price is the denominator of the dividend yield equation, a strong downtrend can increase the quotient of the calculation dramatically.

For example, General Electric Company's (GE) manufacturing and energy divisions began underperforming from 2015 through 2018, and the stock's price fell as earnings declined. The dividend yield jumped from 3% to more than 5% as the price dropped. As you can see in the following chart, the decline in the share price and eventual cut to the dividend offset any benefit of the high dividend yield.

Dividend Yield: Meaning, Formula, Example, and Pros and Cons (2)

Dividend Yield vs. Dividend Payout Ratio

Whencomparing measures of corporate dividends, it's important to note that thedividend yieldtells you what the simple rate of return is in the form ofcash dividendsto shareholders. However, thedividend payout ratiorepresents how much of a company's net earnings are paid out as dividends. While the dividend yield is the more commonly used term, many believe the dividend payout ratio is a better indicator of a company's ability to distribute dividends consistently in the future. The dividend payout ratio is highly connected to a company'scash flow.

Thedividend yield shows how much a company has paid out in dividends over the course of a year. The yield is presented as a percentage, not as an actual dollar amount. This makes it easier to see how much return the shareholder can expect to receive per dollar they have invested.

Example of Dividend Yield

Suppose Company A’s stock is trading at $20 and pays annual dividends of $1 per share to its shareholders. Suppose that Company B's stock is trading at $40 and also pays an annual dividend of $1 per share.

This means Company A's dividend yield is 5% ($1 / $20), while Company B's dividend yield is only 2.5% ($1 / $40). Assuming all other factors are equivalent, an investor looking to use their portfolio to supplement their income would likely prefer Company A over Company B because it has double the dividend yield.

What Does the Dividend Yield Tell You?

The dividend yield is a financial ratio that tells you the percentage of a company’s share price that it pays out in dividends each year. For example, if a company has a $20 share price and pays a dividend of $1 per year, its dividend yield would be 5%. If a company’s dividend yield has been steadily increasing, this could be because they are increasing their dividend, because their share price is declining, or both. Depending on the circ*mstances, this may be seen as either a positive or a negative sign by investors.

Why Is Dividend Yield Important?

Some investors, such as retirees, are heavily reliant on dividends for their income. For these investors, the dividend yield of their portfolio could have a meaningful effect on their personal finances, making it very important for these investors to select dividend-paying companies with long track records and clear financial strength. For other investors, dividend yield may be less significant, such as for younger investors who are more interested in growth companies that can retain their earnings and use them to finance their growth.

Is a High Dividend Yield Good?

Yield-oriented investors will generally look for companies that offer high dividend yields, but it is important to dig deeper in order to understand the circ*mstances leading to the high yield. One approach taken by investors is to focus on companies that have a long track record of maintaining or raising their dividends, while also verifying that those companies have the underlying financial strength to continue paying dividends well into the future. To do so, investors can refer to other metrics such as the current ratio and the dividend payout ratio.

Which Stock Has the Highest Dividend Yield?

This will depend on the timeframe you look at. Dividend yields change daily as the prices of shares that pay dividends rise or fall. Some stocks with very high dividend yields may be the result of a recent downturn in share price, and oftentimes that dividend will be slashed or eliminated by the managers if the stock price does not soon recover.

The Bottom Line

Many stocks pay dividends to reward their shareholders and to signal sound financial footing to the investing public. The dividend yield is a measure of how high a company's dividends are relative to its share price. High-yielding dividend stocks can be a good buy for some value investors, but may also signal that a stock's share price has recently fallen by quite a bit, making the legacy dividend comparatively higher in relation to the share price. A high dividend yield could also suggest that a company is distributing too much profits as dividends rather than investing in growth opportunities or new projects.

Correction - January 10, 2023: This article was corrected from a previous version that incorrectly stated the formula for the dividend payout ratio.

Dividend Yield: Meaning, Formula, Example, and Pros and Cons (2024)

FAQs

What are the cons of dividend yield? ›

The following are the disadvantages: In case the dividend data is old or is based on erroneous information, the evaluation of a stock based on this information is incorrect. Sometimes high yield can be misleading since it may indicate a falling stock price instead of an increase in dividend payment.

What are the pros and cons of issuing dividends? ›

The Pros & Cons Of Dividend Stock Investing
  • Pro #1: Insulation From The Stock Market. ...
  • Pro #2: Varied Fluctuation. ...
  • Pro #3: Dividends Can Provide A Reliable Income Stream. ...
  • Con #1: Less Potential For Massive Gains. ...
  • Con #2: Disconnect Between Dividends & Business Growth. ...
  • Con #3: High Yield Dividend Traps. ...
  • Further Reading.
Nov 22, 2023

What is a dividend yield example? ›

Let's say a public company's share price is $50, and it pays annual dividends equal to $1.50 per share. To determine the dividend yield, divide the dividend amount per share by the price per share: $1.50 / $50 = 0.03. Convert the decimal to a percentage, and you get a dividend yield of 3%.

Is a good or bad dividend yield? ›

Dividend yields over 4% should be carefully scrutinized; those over 10% tread firmly into risky territory. Among other things, a too-high dividend yield can indicate the payout is unsustainable, or that investors are selling the stock, driving down its share price and increasing the dividend yield as a result.

Why is dividend yield negative? ›

No, the dividend yield cannot be negative.

A company pays dividends depending on the company's level of profitability within the given duration. When a company has higher profits, it's likely to pay higher dividends and lower dividends when the profits are low.

What is a major disadvantage of receiving stock dividends? ›

Disadvantages of Dividend-Paying Stocks: 1. Potential for Lower Capital Appreciation: Companies that distribute a significant portion of their earnings as dividends may have less capital available for reinvestment into the business.

Is investing in the dividend good or bad? ›

Is a Stock Dividend a Good or Bad Thing? Dividends are always good, whether they're in shares or cash. However, if you're buying dividend-paying stocks to create a regular source of income, you might prefer the money.

How much can you make in dividends with $100K? ›

How Much Can You Make in Dividends with $100K?
Portfolio Dividend YieldDividend Payments With $100K
1%$1,000
2%$2,000
3%$3,000
4%$4,000
6 more rows
Mar 23, 2024

What is a dividend yield for dummies? ›

The dividend yield is a financial ratio that tells you the percentage of a company's share price that it pays out in dividends each year. For example, if a company has a $20 share price and pays a dividend of $1 per year, its dividend yield would be 5%.

How do dividend yields pay? ›

Dividend yield is a stock's annual dividend payments to shareholders expressed as a percentage of the stock's current price. This number tells you what you can expect in future income from a stock based on the price you could buy it for today, assuming the dividend remains unchanged.

What are good dividend yields? ›

9 Highest Dividend-Paying Stocks in the S&P 500
StockTrailing annual dividend yield*
AT&T Inc. (T)6.3%
Verizon Communications Inc. (VZ)6.3%
Healthpeak Properties Inc. (DOC)6.6%
Altria Group Inc. (MO)8.8%
5 more rows
Mar 29, 2024

How often is dividend yield paid? ›

Dividends, a distribution of a portion of a company's earnings, are generally paid in cash every quarter to shareholders. The dividend yield is the annual dividend per share divided by the share price, expressed as a percentage; it will fluctuate with the price of the stock.

How often do dividends pay? ›

Dividends are typically issued quarterly but can also be disbursed monthly or annually. Distributions are announced in advance and determined by the company's board of directors. Companies pay dividends for a variety of reasons, most often to show their financial stability and to keep or attract investors.

Does Amazon pay dividends? ›

Does Amazon distribute dividends? We have never declared or paid cash dividends on our common stock.

What are the benefits of issuing dividends? ›

There are a couple of reasons that make dividend-paying stocks particularly useful. First, the income they provide can help investors meet liquidity needs. And second, dividend-focused investing has historically demonstrated the ability to help to lower volatility and buffer losses during market drawdowns.

What are the effects of issuing dividends? ›

When the dividends are paid, the effect on the balance sheet is a decrease in the company's retained earnings and its cash balance. In other words, retained earnings and cash are reduced by the total value of the dividend.

What are the advantages and disadvantages of issuing shares? ›

Advantages and disadvantages of issuing shares in your company
  • new finance.
  • an exit for founding investors who want to realise their investment.
  • a mechanism for investors to trade shares.
  • a market valuation for the company.
  • an incentive for staff using shares or share options.
  • an acquisition currency in the form of shares.

Why would a company want to issue dividends? ›

Paying dividends allows companies to share their profits with shareholders, which helps to thank shareholders for their ongoing support via higher returns and to incentivise them to continue holding the stocks.

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