What is the Dividend Yield?
The Dividend Yield is defined as the ratio between the dividend paid per share (DPS) and the current market share price of the issuer.
- What does the dividend yield represent?
- What is the formula for calculating the dividend yield?
- Should the quarterly or annual dividend per share (DPS) be used in the calculation?
- How is the dividend different from the dividend payout ratio?
Table of Contents
Dividend Yield Formula
The dividend yield represents how much a company issues in dividends relative to its latest closing share price – i.e., the percentage of its share price paid out in the form of dividends each fiscal year.
Dividend Yield Formula
- Dividend Yield = Annual Dividend Per Share / Current Share Price
However, since dividends are paid quarterly, the standard practice is to estimate the annual dividend amount by multiplying the latest quarterly dividend amount per share by four.
As a result, the dividend yield reflects any recent corporate changes regarding the payout policy.
For example, if a company is trading at $10.00 in the market and issues a dividend per share (DPS) of $1.00 per year, the company’s dividend yield is equal to 10%.
Interpreting the Dividend Yield
If a company’s dividend yield has been steadily increasing over time, such changes could be interpreted positively if caused by an increasing dividend payout.
But if the dividend yield increases due to a declining share price, that is typically concerning.
Management’s decision to cut the dividend amount can also cause dividend yields to decline.
Considering companies are reluctant to cut dividends once implemented, an announcement that dividends are being cut is almost always perceived negatively.
Hence, there tends to be a drop-off in a company’s share price following news that its dividend is being reduced (or completely cut) – as investors tend to assume the worst.
Company Lifecycle – Dividend Yield Relationship
The maturity of the company and the defensibility of its market share (i.e. number of new entrants, threat of disruption) must be taken into consideration when it comes to dividend yield comparisons.
Mature companies in established markets tend to pay regular dividends with consistent dividend yields.
But companies earlier in their lifecycle experiencing high growth – assuming the company is profitable – tend to reinvest their earnings for further growth instead of issuing dividends.
Generally, the dividend yield metric is most useful for comparisons to historical yields, as well as to the industry average, rather than for direct comparisons with peers, given the number of variables that can impact the dividend policies between companies.
Dividend Yield vs. Dividend Payout Ratio
Other than the dividend yield, another popular metric for investors is the dividend payout ratio.
While the dividend yield is the rate of return of dividends paid to shareholders, the dividend payout ratio is how much of a company’s earnings are paid out as dividends instead of being retained.
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’s cash flow.
Since the yield is denoted as a percentage, shareholders can easily assess their expected returns per dollar invested.
Dividend Yield Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Dividend Yield Example Calculation
Suppose we have two companies – Company A and Company B – each trading at $100.00 with an annual dividend per share (DPS) of $2.00 in Year 1.
From Year 2 to Year 5, Company A’s DPS will increase by $0.50 each year until reaching $4.00 by the end of the forecast.
Across the same time horizon, Company B’s share price will decline by $12.50 each year – falling to $50.00 by the end of Year 5.
We arrive at the dividend yield by dividing the current share price by the dividend per share, as shown below.
The dividend yield of both companies increases from 2.0% in Year 1 to 4.0% in Year 5.
However, the cause of each company’s dividend yield increase determines whether the increase should be determined positively or negatively.
Company A is likely to become more profitable and therefore increase the dividend payout to shareholders.
By contrast, Company B’s share price has effectively been cut in half, implying some underlying issues (e.g. missed earnings, negative market sentiment).