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.
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 2021, Qualcomm Incorporated (QCOM), an established telecommunications equipment manufacturer, had a trailing twelve months (TTM) dividend of $2.63.1 Using its current price of $144.41 on August 17, 2021, its dividend yield would be 1.82%.2 Meanwhile, Square, Inc. (SQ), a relatively newer mobile payments processor, pays no dividends at all.
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Calculating the Dividend Yield
The formula for dividend yield is as follows:
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.
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