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Understanding Dividend Yield

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45 dividendyield 421x236 However, if you are a value investor or looking for dividend income then there are a couple of measurements that are specific to you. For dividend investors, one of the telling metrics is Dividend Yield.

This measurement tells you what percentage return a company pays out to shareholders in the form of dividends. Older, well-established companies tend to payout a higher percentage then do younger companies and their dividend history can be more consistent.

You calculate the Dividend Yield by taking the annual dividend per share and divide by the stock’s price.

Dividend Yield = annual dividend per share / stock's price per share

For example, if a company’s annual dividend is $1.50 and the stock trades at $25, the Dividend Yield is 6%. ($1.50 / $25 = 0.06)

Dividend Yield = Annual Dividend / Current Stock PriceFor example, let's assume you own 500 shares of Company XYZ, which pays $1.10 per share in annual dividends. If the current stock price is $12.00, then using the formula above we can calculate that the dividend yield on Company XYZ stock is:$1.10 / $12.00 = .0916 = 9.2%Note that there is an inverse relationship between yield and stock price. For example, if the stock price rose to $15, the yield would be $1.10/$15 or 7.3%. The 500 share investment would be worth $7,500 (vs. $6,000 originally) but the yield on the investment would fall from 9.2% to 7.3%.Further note that the dividend stays the same, meaning even though the stock price falls (or rises), you still receive $1.10 per share (unless the company changes the dividend).

Why it Matters:
Dividend yields are a measure of an investment’s productivity, and some even view it like an "interest rate" earned on an investment.A security's dividend yield can also be a sign of the stability of a company and often supports a firm's share price. Normally, only profitable companies pay out dividends. Therefore, investors often view companies that have paid out significant dividends for an extended period of time as "safer"investments. Thus, should events occur which are detrimental to the share price, the allure of the dividend combined with the stability of the company can support the price somewhat.

Price-to-Earnings ratio, or P/E ratio

price-to-earnings ratioIt is defined as market price per share divided by annual earnings per shareAs an example, if stock A is trading at $24 and the earnings per share for the most recent 12-month period is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of the stock is paying $8 for every dollar of earnings. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as "not applicable" or "N/A"); sometimes, however, a negative P/E ratio may be shown.