Dividend Yield

What is Dividend Yield?

The dividend yield depicts the relationship between a stock’s annual dividend payout and its current stock price. It is a ratio (expressed as a percentage) that measures the dividends paid to shareholders relative to the market value per share.

Investors use the dividend yield ratio to measure the amount of cash flow they would receive for each dollar invested in an equity position over the period. In other words, the dividend yield shows investors the return on their investment for a stock without including capital gains.

Some stocks do not pay a dividend, so this metric is only useful for stocks that do. Typically, stocks held only for capital growth (and not dividend income) are newer companies or those still investing in growth and expansion, so do not allocate capital to pay dividends to shareholders.

A high dividend yield suggests that a company is paying a significant share of its profits to shareholders as dividends. That means the company does not keep the majority of profits as retained earnings to grow the business through investments and acquisitions. These types of stocks are called income stocks and are typically mature companies with established market share and infrastructure, so can pay out profit to shareholders rather than reinvesting them in the company.

The dividend yield can be impacted by two key variables, the amount of dividends being paid out, and the stock price.

Dividend Yield is a Key Ratio

The dividend yield ratio is impacted by the daily movements in the stock price. A dividend-paying company will have an established dividend policy where it targets a certain payment threshold (or targets a growing dividend each year) to return to shareholders.

When a stock price is consistently trending upwards, a company may raise its dividend payout to maintain the dividend yield. A significant increase in a stock’s price but no adjustment to dividends will result in a decrease in the dividend yield.

Dividend Yield Ratio

The dividend ratio is calculated by taking the annual dividend and dividing by the stock price. This is then multiplied by 100 to make it a percentage.

Dividend Yield Ratio = (Annual dividend / stock price) x 100

Example

Here is an example of a dividend paying company and we can calculate the dividend yield.

Company A	$
Annual dividend paid	2.4
Stock price	48

To calculate the dividend yield we can take the annual dividend of $2.40 per share and divide it by the stock price of $48.

Dividend yield ratio = (2.4 / 48) x 100

=5.0%

This gives a dividend yield of 5.0%.

Points to Note

The example shows that Company A’s ratio of 5% means that it pays a significant portion of its retained earnings to shareholders as dividends.

If the dividend rose to $3.00, the dividend yield would be 6.25%

Conversely if the stock price fell to $40 with the original $2.40 dividend, the yield would be 6.0%

Real-World Example – Apple

This real-world example is taken from Apple Inc, which has a strong track record of paying dividends to shareholders.

As of September 28, 2024, the Company’s quarterly cash dividend was $0.25 per share. The Company stated that it intended to increase its dividend on an annual basis, subject to declaration by the Board.

The annual dividend per share is shown at the bottom row of this table. We can see it has risen by 4 cents (or just over 4%) annually for the past two years.

Source: Felix

This table showing Apple’s Consolidated Statements of Shareholder’s Equity (in millions, except per-share amounts) can be downloaded from Felix. It details the total dividends paid out for the last 3 years.

Real-World Example – Hershey

Below is an extract from The Hershey Company Notes of Consolidated Financial Statements at December 31, 2019 and is another way of finding out dividend information from company financials:

“Dividend yields” in this 10K means the sum of dividends declared for the four most recent quarterly periods, divided by the average price of the common stock for the comparable periods. More details about a company’s divided policy can be found in the company MD&A and Financial Statements.

Importance of Dividend Yield Ratio

Often low growth companies will trade on high dividend yields. These are largely mature companies who have reached optimal size and are generating a significant amount of cash.  They can start returning cash to shareholders in the form of dividends and are known as ‘income stocks’.

In the Oil Sector, low dividend yield stocks tend to have a lot of new investment opportunities so the market is comfortable that they retain the earnings and reinvest them in the operations of the business.

Investors who want regular income find high dividend yield stocks appealing. However, investors need to determine if the dividend is sustainable – can the company sustain that level of dividend payment or is it paying too much out of its profits?

Interaction Between Dividends and Valuation

Let’s look a little bit closer at the relationship between dividends and valuation with an example using two companies: Watercombe Inc and Wharf Inc.

	Watercombe Inc.	Wharf Inc.
Net income	10.0	10.0
Dividend payout	20%	20%
Dividends	2.0	2.0
Stock price	100.0	150.0
Dividend yield	2.0%	1.3%
PE multiple	10.0	15.0

 

Here, both companies currently have the same income of $10 and dividend of $2.00 per share so therefore both will have an identical payout ratio. However, the stocks have different stock valuations so the dividend ratios will vary.

Wharf has a much higher valuation and trades on a higher price earnings multiple of 15.0x versus Watercombe on 10.0x. What we could infer from this is that the market expects Wharf to have higher return on investment (or greater earnings growth) than Watercombe and this is deemed more valuable than Watercombe.

As the market is putting a higher value on Wharf reflecting higher value growth in the future the stock will therefore trades on a lower dividend yield. Should the company deliver strong earnings growth in the future then it may increase its dividend payout to achieve a higher yield to attract investors.

Download the free Financial Edge dividend yield template to assist with yield calculations plus an exercise to assess the yield and valuation of these example companies.

Understanding Dividends

Dividends are payments made by a corporation to its shareholders, usually in the form of cash or additional shares. They are typically distributed from the company’s profits. A company will determine its own dividend policy as part of its overall management strategy. This will include plans to create value to shareholders either through business expansion, improved cash flow, share buybacks or dividend payments.

REITs, MLPs, and BDCs

There are several types of special purpose vehicles which target paying out dividends to their shareholders:

REITs (Real Estate Investment Trusts): companies that own, operate, or finance income-producing real estate. They are required to distribute at least 90% of their taxable income to shareholders as dividends.

MLPs (Master Limited Partnerships): publicly traded partnerships that typically operate in the energy sector. They offer tax advantages and high yields.

BDCs (Business Development Companies): investment companies that invest in small and mid-sized businesses. They are required to distribute at least 90% of their income to shareholders.

Advantages and Disadvantages of Dividend Yields

There are several advantages to owning stock with high dividend yields:

Advantages:

• A portfolio of high yield dividend stocks will provide a steady income stream for an investor
• A high yielding stock typically indicates that the stock is in good financial health and profitability, particularly if a mature company with a strong track record
• Dividend payments are usually a sign of a company’s commitment to returning value to shareholders

However, there may be other concerns with stocks that offer a high dividend yield – most notably because the stock price may have fallen – and thus the yield looks higher than it would ordinarily look.

Disadvantages:

• High dividend yields can sometimes indicate a struggling company where the stock price is falling or has dropped
• Dividends are not guaranteed and can be cut or suspended so investing in a stock simply for its upcoming dividend may be risky
• Stocks that pay out good dividends may offer less capital appreciation than non-dividend paying stocks

Dividend Yield vs. Dividend Payout Ratio

These dividend ratios measure dividend payments from two perspectives:

Dividend Yield: this measures the annual dividends paid out relative to the stock price.

Dividend Payout Ratio: measures the percentage of earnings paid out as dividends relative to income. It is calculated as:

Dividend Payout Ratio = Net Income divided by Dividends Paid

Tax Considerations of Dividends

Dividends can be taxed differently depending on the type:

• Ordinary Dividends: taxed at the individual’s ordinary income tax rate
• Qualified Dividends: these are ordinary dividends reported by the shareholders to the IRS and then taxed at the lower capital gains tax rate

• Taxation will depend on the jurisdiction of where the investors are based and where the company is based in most situations.

Dividend Yields and Inflation

Periods of higher inflation can erode the purchasing power of dividend income for investors. Companies that can increase their dividends ahead of inflation rates can help offset this and maintain the purchasing power of the income received.

What Does the Dividend Yield Tell You?

The dividend yield provides insight into the income generated from an investment relative to its stock price. It helps investors assess the potential return on investment from dividends alone. Here are some of the areas of insight that it can provide:

Income Potential:

• A higher dividend yield means more income relative to the stock price
• Useful for investors who prioritize regular income (e.g. retirees)

Valuation Insight:

• A rising dividend yield (if caused by a rising dividend payment) may indicate a robust company generating strong cash flows
• A rising dividend yield (if caused by a falling stock price) may indicate a troubled company
• A declining yield could suggest a rising stock price or a dividend cut

Risk and Stability:

• Although a high dividend yield can be attractive for investors, very high yields can be a red flag – possibly unsustainable or a sign of financial distress
• Stable, moderate yields often indicate mature, financially healthy companies

Comparison Tool:

• Dividend yield helps compare income potential across different stocks, sectors, or even against fixed-income investments (like bonds)

Why Is Dividend Yield Important?

Dividend yield is important because it helps investors understand the income potential of their investments and compare it with other income-generating assets.

It can also be used as a threshold to allocate companies (which pay dividends) into low, medium or high dividend yield ranges. Companies experiencing financial distress (and a falling stock price) may move from a low yield into a higher dividend yield category. This may make them more attractive to an investor willing to take the additional risk or it may be a warning signal for investors relying on the stock for regular dividend payments.

Is a High Dividend Yield Good?

A high dividend yield can be attractive, but it may also indicate potential risks such as financial instability or declining stock prices. It is essential to evaluate the underlying reasons for a high yield when assessing whether to invest or not. Yields can be compared to historic performance and also the relative performance of the market and peer group.

Conclusion

Dividend yields are essential for investors to assess the income potential of their investments and compare it with other assets. While high dividend yields can be attractive, they may also indicate potential risks such as financial instability or limited growth opportunities. Therefore, it’s crucial to evaluate the sustainability of dividends and consider other factors like the company’s overall financial health. By understanding and utilizing dividend yields, investors can make more informed decisions and achieve their financial goals.