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Summary
- A dividend yield is a financial ratio calculated as annual dividend per share over market price per share.
- Large, mature companies from utilities, consumer staples, telecom, energy sector generally provide a dividend to their shareholders.
- A higher dividend yield indicates sound financial health of a Company. However, an exceptionally high dividend could be alarming.
- Experts consider annual dividend in the range 2%-6% as ideal.
A dividend yield, expressed as a percentage, is a financial ratio that tells how much a company is paying the dividend to its shareholders compared to its stock price. Investing in stocks with a high dividend yield is considered a good source of income. However, one should also find the reason for the high dividend yield before making any investment decision.
Generally, large, mature companies, primarily from utilities, consumer staples, banks, telecom, and energy space, pay dividends to their shareholders. Besides, REITs, master limited partnerships and business development companies provide more than an average dividend. However, they are taxed at a higher rate.
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How do we calculate annual dividend yield?
To calculate the annual dividend yield, one needs to divide the annual dividend provided per share by the share price.
Dividend Yield = Annual Dividend per share/price of stock per share
For example, if a company provides a quarterly dividend, one can multiply the quarterly dividend by four to get the annual dividend. One can also be calculated by adding the dividend amount provided in four quarters to get the annual dividend.
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Significance of dividend yield
Dividend yield helps us identify stocks providing a high return on each dollar spent by the investor. However, dividend yield offers other benefits too.
- Dividend helps in comparing stocks easily.
- An increase in dividend yield indicates that the Company is performing well.
- Increased dividend yield also increases the return when the investor reinvests the dividend into the Company's shares instead of cashing it.
Risks from increased annual dividend yield
An increased dividend yield generally indicates that a Company’s financial health is good. However, if a company has an exceptionally high dividend yield, it could be a matter of concern. The possible reasons could be:
- A sudden drop in the stock price.
- The Company is trying to give its stock prices a lift by improving the dividend to entice new investors. Seeing the increased dividend yield might attract a few investors, and there could be an increase in the share price.
What is a good dividend yield?
During unfavourable market situations, dividend yield is an essential factor that investors with a low-risk appetite look at while picking any stock. However, on the other side, when the market is bullish, investors prefer capital appreciation over dividend yield.
Investors look at dividend yield to assure some amount in return on their investment, despite share price remaining subdued. An increased dividend yield acts as a cushion for stocks during the market downturn.
Generally, dividend yield is compared with bonds as both investments provide investors with a regular income source. To find whether a stock has a good dividend yield or not, one can compare it with the government bond yield. If a 10-year government bond dips below, say 6%, it would make a high dividend yield stock look much attractive. At the same time, experts also suggest people consider other factors along with annual dividend yield while picking stocks. These factors include the Company's earnings, outlook, and all the factors mentioned earlier in this article.
What is the range of a good dividend yield?
While an increased dividend yield indicates the Company's sound financial health, some factors boost the annual dividend, like a sudden drop in share price. So, the most common question which can come to mind is that what is the ideal range?
Experts believe that the ideal range of annual dividend yield is between 2% to 6%. The range usually determines that the stock has attained a growth point where it can generate real income without borrowing or self-destructive measures. If we see the annual dividend yield of blue-chip companies generally fall in this range.
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