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Dividend yield shows how much a company pays out in dividends relative to its stock price. Dividend yield lets you evaluate which companies pay more in dividends per dollar you invest, and it may also send a signal about the financial health of a company.
What Is a Dividend?
A dividend is a portion of a company’s profits that it distributes to shareholders. Dividends are paid out in addition to any gains in the value of the company’s shares and reward shareholders for holding a stock.
Companies in certain sectors are known for paying dividends, and dividends are more common among established companies that can afford not to invest all of their profits back into the business. Companies might pay special, one-time dividends, or they may pay dividends at regular intervals, such as every quarter or once a year.
One of the big advantages of preferred stock is that it dependably pays regular dividends, although common stock may also pay out regular dividends. Unlike bond interest payments, however, dividend payments are not guaranteed. Companies may cut or even eliminate dividends when they experience hard economic times.
What Is Dividend Yield?
Dividend yield is the percentage a company pays out annually in dividends per dollar you invest. For example, if a company’s dividend yield is 7% and you own $10,000 of its stock, you would see an annual payout of $700 or quarterly installments of $175.
Companies generally pay out dividends based on the number of shares you own, not the value of shares you own, though. Because of this, dividend yields fluctuate based on current stock prices. Many stock research tools list recent dividend yields for you, but you can also calculate dividend yield yourself.
Dividend Yield Formula
If a stock’s dividend yield isn’t listed as a percentage or you’d like to calculate the most-up-to-date dividend yield percentage, use the dividend yield formula. To calculate dividend yield, all you have to do is divide the annual dividends paid per share by the price per share.
Dividend Yield = Annual Dividends Paid Per Share / Price Per Share
For example, if a company paid out $5 in dividends per share and its shares currently cost $150, its dividend yield would be 3.33%.
You can find a company’s annual dividend payout in a few different ways:
- Annual report. The company’s last full annual report usually lists the annual dividend per share.
- Most recent dividend payout. If dividends are paid out quarterly, multiply the most recent quarterly dividend payout by four to get the annual dividend.
- “Trailing” dividend method. For a more nuanced picture of stocks with changing or inconsistent dividend payments, you can add up the four most recent quarterly dividends to get the annual dividend.
Keep in mind that dividend yield is rarely consistent and may vary further depending on which method you use to calculate it.
Why Is Dividend Yield Important?
The primary reason to understand dividend yield is to help you understand which stocks offer you the highest return on your dividend investing dollar. But there are a few other benefits to consider.
Dividend Yields Make It Easy to Compare Stocks
If you’re an income investor, you’ll want to compare and select stocks based on which pay you the highest dividend per dollar you invest. The absolute dividend amount you receive per share is a less helpful metric because companies have widely varying stock prices.
For example, Companies A and B both pay an annual dividend of $2 dividend per share. Company A’s stock is priced at $50 per share, however, while Company B’s stock is priced at $100 per share. Company A’s dividend yield is 4% while Company B’s yield is only 2%, meaning Company A could be a better bet for an income investor.
Increasing Dividend Yields Indicate Financial Health
If a company chooses to raise its dividend—and therefore raise its dividend yield—this generally tells investors that the company is doing well since it can afford to pay out more of its profits to shareholders.
Generally speaking, older, more mature companies in settled industries tend to pay regular dividends and offer better dividend yields. Meanwhile, younger, faster-growing companies tend to reinvest their profits for growth instead of paying out a dividend.
Dividends Boost Your Returns
When you reinvest your dividends, instead of cashing them out every year or quarter, your investment benefits from compounding. Over time, compounding effects can drastically enhance your returns. A recent report from Hartford Funds indicates that since 1970, 78% of the total returns of the S&P 500 can be attributed to reinvested dividends.
The Dangers of High Dividend Yields
A high dividend yield isn’t always a positive sign. In fact, an unexpectedly high yield could actually be a red flag. This might happen for a couple of reasons:
- The company’s stock price has recently plummeted. If a stock has seen a dramatic price decline and its dividend hasn’t been cut yet, the yield can appear high. Consider a company that pays a $2 annual dividend per share with a stock price of $60. If its price falls to $20, its dividend yield almost triples to about 10%. This yield might look really favorable at first glance, but on deeper examination it actually signals that the company is in trouble because its share price has dropped sharply. This means that a dividend reduction or elimination may follow soon.
- The company is attempting to woo investors with a high dividend payment. Some companies try to give their stock prices a boost by increasing the dividend to attract new investors. Impressed by the high dividend yield, some investors may buy shares, driving up the stock price. But this dividend payout—and increased stock value—may not last if the company isn’t financially stable and can’t afford to maintain the higher dividend payments.
With that in mind, it can make sense to look for companies with lower, but consistent, dividend yields or to carefully invest only in high-dividend stocks that have solid financials and pay rates similar to others in their industry.
Best Dividend Yield Stocks
If you’re looking for high dividend yields, look to the dividend aristocrats, which have consistently raised their dividend payouts over decades, as well as stocks in the following sectors:
- Utilities. In general, electricity and water suppliers offer high, consistent dividends. Even natural gas suppliers have provided relatively high, stable dividends in the past.
- Consumer staples. Companies that offer consumer staples often have long-standing dividend programs. In fact, many dividend aristocrats are consumer staples companies.
- Telecommunications. Companies that provide telephone and internet services often offer fairly high dividends.
- Energy. Companies that supply energy often have higher dividends. This is in part because many are master limited partnerships (MLPs) that must pay out all of their profits to shareholders to maintain their tax advantaged status.
- Real estate. Similarly to MLPs, real estate investment trusts (REITs) must distribute almost all of their profits to shareholders as dividends to keep their tax status. This can lead to much higher than average dividend yields.
