Dividend yield is a financial ratio that shows how much a company pays in dividends each year relative to its stock price. This is expressed as a percentage.
The formula for dividend yield is:
Dividend Yield = Annualized Dividend per Share ⁄ Total Stock Price
For example, if a stock is valued at $100 and the company’s annualized dividend is $1 per share, the dividend yield is 1%.
You can calculate the dividend yield from a company’s last full year financial report. The further away from the report being released, the less reliable the result is.
Investors can counteract this by taking the last quarterly dividend and multiplying it by four to use as the annualized dividend per share, however, this also may not be accurate. Not all companies pay an even quarterly dividend; this will create an inaccurate dividend yield calculation. Dividends can be paid annually, quarterly, monthly or a mixture of the three.
For best results, an investor should research the history of a company’s dividend payments to decide which method will give the most accurate results.
It is important to remember, as long as the dividend is not changed, the dividend yield will fluctuate alongside the stock price. Taking our example from above, if the stock value drops to $10 and the annualized dividend doesn’t change, the dividend yield will be 10% — despite the payout not changing. This can be misleading for investors.
You can expect smaller companies to have smaller dividend yields and more mature companies to have higher dividend yields.
Real estate investment trusts (REITs), average dividend yield is very high. However, these are ordinary dividends rather than qualified dividends. Ordinary dividends are taxed as regular income, whereas qualified dividends are taxed as capital gains — the latter is a lower rate of taxation.
There are also companies that are required (by the U.S. Treasury) to pay the majority of their income to their shareholders. This is called a pass-through process, this allows companies to not pay income tax on profits that they pay out as dividends. Master limited partnerships (MLPs) and business development companies (BDCs) are two examples of this and usually have high dividend yields.