What is meant by stock yield?

The stock yield is otherwise known as the dividend yield. The dividend yield is an annual payment of the stock dividends to the holder of a firm’s stock. The dividend yield is a financial ratio to measure the value of dividend payout every year for the relative stock price. The yield of a stock is usually shown in a percentage that discloses the expected future earnings from stock depending on the current stock price in the future. Stock yield will change depending on the market fluctuations and in accordance with the market fluctuations, the dividends will be increased or decreased by the firm.

The formula of dividend yield

$\mathrm{Dividend} \mathrm{Yield} =\frac{\mathrm{Dividend} \mathrm{Per} \mathrm{Share} }{\mathrm{Market} \mathrm{Value} \mathrm{Per} \mathrm{Share} }$

Example

A firm pays $10 as dividend per share annually. The market price of a share is $50. Calculate the dividend yield ratio.

$\begin{array}{rcl}\mathrm{Dividend} \mathrm{Yield}& =& \frac{\$10}{\$50}\\ & =& 20\%\end{array}$

The ratio of dividend yield for the firm is 20%. Therefore, an investor can earn 20% on shares in the firm as a dividend.

Why dividend yield is important?

The portion of the profit is distributed as a dividend to the shareholders. The dividend yield is considered as the financial health of a firm to pay a dividend for stock. A high dividend yield stock could be an attractive investment for investors who rely on the financial gain from their investment such as widows and retired persons. Some investors especially youngsters do not concentrate more on the yield of a stock because of their risk tolerance. The long-term investor would seek more yield from the stock so that they can reinvest the income to buy more stocks.

How to choose a dividend stock yield?

An investor must research the yield of a stock before buying a stock. Earning a high dividend from stock will not be treated as a good investment. Many investors will add high-yield dividend stock to their portfolios for various reasons. The following are important notes to be considered before buying a stock in the market:

Growth of dividend

An investor should review the history of the firm before making an investment. He should check whether or not the firm has rewarded the stockholders with a regular dividend for every stock they held and also observe whether or not the dividend rate is increasing.  A good firm should have a gradual rise in dividend payment over the years. Dividend aristocrats are companies in the S&P 500 index that have increased the dividends for 25 years and also pay a dividend to the shareholders consistently.

Financial position

The financial position of a firm plays an important role in the stock market. By seeing the debts of a firm, an investor will have a plan concerning the dividend payment. If the firm has more long-term borrowing, then the dividend payments would be less. The working capital of the firm shows the competency of a firm to meet the economy in the respected industry. The cash flow of the firm also determines the dividend payment for a stock.

Regularity of dividend

A dividend policy discloses the regularity of dividend payment in a firm. The management decides on the dividend policy for the shareholders. A stable dividend payment would attract an investor to buy stock in a firm and also create an impact on the market price of a stock. The dividend payment always fluctuates from year to year, however, paying a regular dividend would increase the demand for stock in the market. Some firms have a record of paying a dividend for the stock even in the heavy unbroken period.

Dividend traps

A high dividend yield will not be a positive sign from a firm's investment perspective. In such a firm, all the profits will be distributed to the stockholders. The firm will not have enough cash to fund the new investment opportunities prevailing in the market. Many investors fall for the high dividend-paying stock, hoping to get more return from the stock investment. A high dividend-paying firm will not be a good performer in the industry, and shortly the business would wind up.

How to locate the dividend yield of a stock?

Finding a firm’s stock yield is more difficult. There are many methods and approaches used to identify the stock yield. It is a better option to look for the dividend yield of a stock by looking into the history of dividend payment of a firm.

Recent financial report

A firm’s dividend payment can be recognized with the help of the firm's financial report released by it. The most recent financial report would have contained the firm’s performance with relevant financial data. However, the dividend payment strategy and other factors might have changed after the disclosure of the report.

Dividend payment trail

A firm’s yield of a stock can be found by trailing dividend data. This method shows the dividend payment of the stock for the past 12 months. A drawback of calculating the yield of the stocks using the data is that the firm’s recent current performance will not be known.

Recent quarterly dividend

For calculating the dividend yield, the firm’s most recent quarterly dividend can be used. By multiplying the quarterly dividend by four, the annual dividend can be obtained, and then the annual dividend can be used to calculate dividend yield which would be helpful to identify the stock yield.

Context and Applications

This topic will be helpful for students who prepare for exams for courses such as

• Associate of Arts Degree in Economics
• Master of Accountancy
• Business Administration (Finance and Banking)
• Business Administration (International Business - Finance)
• Investment, Graduate Certificate
• Bachelor of Science in Finance (Business Administration)

Practice Problems