WHAT IS
DIVIDEND YIELD

Dividend yield can help you measure and assess the potential returns on a dividend stock investment. Keep reading to learn how to calculate dividend yield and how to use it as part of your investment strategy.

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Investing in dividend stocks offers a way to generate a passive income, but what metrics can you use to find an investment that suits your personal investment goals? Dividend yield is one measure that is commonly used to assess the potential returns on an investment. This calculation aims to establish whether the stock typically pays a large or small dividend, and can be used to compare different stocks relative to each other. 

What is a dividend yield?

A dividend yield is the numerical outcome of a formula that expresses the size of the annualized dividend payment as a percentage of a stock’s current share price. Dividend yield analysis is used to make predictions about the future of dividend payments.

The equation is not difficult to calculate, but it can seem confusing at first. While stock prices are easy to track, the size of future dividends is harder to predict. This is because dividends are paid at the discretion of a company’s management team, and are based on the underlying performance of the business, which can fluctuate or change over time.

It is important to note that dividend yield analysis relies on the assumption that historical dividend payments can predict future payments. This is not always true; companies can decide to change their dividend rate or stop paying them all together, at any time. For these reasons, dividend yield should not be relied upon as a certainty and investors should ensure that they understand the risks of dividend investing, while knowing how to mitigate against them through construction of a diversified portfolio and a well-researched dividend investment strategy.

How to calculate dividend yield

The first stage of a dividend yield calculation involves totaling the dividend payments made over the last year. If the stock in question paid quarterly dividends, then you will need to calculate the total of those four amounts. If it paid dividends annually, then there is only one number to factor into your equation. Given the usefulness of dividend yield in analysis, reputable brokers will likely have an automated display of this information available on their site. You will also need to know the company’s current stock price, which can be found by gaining access to a trading platform.

Dividend yield formula

One of the reasons that dividend yield is such an effective and popular metric is that the dividend yield calculation formula is relatively straightforward:

• Dividend Yield = Annual Dividend / Current Stock Price

What is a dividend yield ratio?

The dividend yield ratio is calculated in a similar way to the dividend yield, but instead of using annualized dividend payments, it uses a firm’s net income instead. It can be a useful metric, as it offers another level of insight into a firm’s operations and prospects. 

For instance, a company’s management may be holding back profits with the intention of using them for capital investment, rather than paying those profits out to shareholders as dividends. Or it may be paying a dividend that is too large in size, considering its recent performance.

The former situation could be a sign that dividend payments may be restored to a higher level at some point in the future, and the second would raise questions about the long-term viability of dividend payments remaining high.

• Dividend Yield Ratio = Annual Income / Current Stock Price

Dividend yield examples

Stock prices and dividend payments are constantly changing. However, the stocks of some companies are considered “dividend stocks,” because they have an established track record of sustaining a relatively high dividend yield over an extended period of time. An example of a well-known company that falls into this category is communications giant Verizon, which has, since 2008, recorded a dividend yield in the region of 5%.

Consider some more real-world examples:

Company	Dividend yield (as of March 2024)
British American Tobacco	Around 9.5%
Rio Tinto Ltd	Around 5.3%
Duke Energy Corp	Around 4.3%

To better understand how dividend yield works, and changes, it can be useful to consider a theoretical example. 

Imagine that a stock has a price of $100 per share, and pays an annual dividend of $5. In this case, the dividend yield would be 5%. Should the stock price fall to $50, and the dividend remain the same, then the dividend yield would increase to 10%. Similarly, if the stock price remains the same but the dividend payout changes, then that would also result in the dividend yield changing.

How are total dividend stock returns calculated?

To calculate the total return from an investment in a dividend stock, an investor should follow the relatively straightforward dividend stock returns formula:

• (Dividend Income + Capital Appreciation) – Capital Gains Tax = Total Dividend Stock Return

The formula can be explained further by breaking down the three main elements in more detail:

The capital appreciation (or “capital gain”) — Realized when an investor sells their holding, reflecting any price change in the market value of the asset. As investors typically look to sell investments for profit, this is likely to be a positive value.

Income earned (or “dividend yield”) — Includes any dividend returns received or reinvested throughout the holding period. Some investors opt to automatically reinvest their dividends into their position as soon as they are paid, while others will take them paid directly as passive income. This is often referred to as accumulation vs distribution of dividends but will need to be calculated either way.

Tax implications — Capital gains tax (CGT) is levied on a profitable sale of an eligible asset, and the rate at which an investor pays CGT will depend on a combination of general guidelines, national tax rates and personal circumstances. Investors should always remember that their total return is likely to face a tax deduction.

You will need to establish your capital gain, dividend income, and CGT obligation to identify your total profit or loss on a dividend stock.

What is a good dividend return?

Dividend yield is one of the key metrics by which you can establish if a stock might generate a good dividend return. If you want to measure a stock’s dividend yield against a benchmark, then you could compare it against the average dividend yield for the sector in which it operates, or against the average for the stock exchange on which it is listed.

Even if a target stock has a yield above the market average, it’s still worth remembering that dividends aren’t the only factor to consider when deciding which stock to buy. Growth stocks typically don’t pay dividends, as company profits are instead reinvested in new projects. If this boosts net earnings, it can result in an increase in the share price anyway, which might outperform the combined capital and income gains received on a dividend stock.

Final thoughts

The dividend yield formula allows you to understand a stock’s nature and is a simple and robust metric that can help you filter your search. As with most analytical tools, it is best used in conjunction with other elements of technical and fundamental analysis to build up a more rounded idea of potential returns.

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FAQs

What is TTM?

The term “trailing 12 months” (TTM) dividend yield explains the process of calculating dividends paid over the previous 12 months.

Do stock valuation methods factor in dividends?

Dividends can be an important element of any net return on your investment, but many stock valuation models focus on other factors. The discounted cash flow method, for example, considers the size and growth of total earnings rather than whether profits are paid out in the form of dividends.

How can I keep track of dividend payments?

A good broker will provide you with a dividend calendar, which will give data on historical payouts, and the dates of upcoming dividend payments.