Dividend investing is a great way to ensure a steady stream of income from your investment portfolio. Dividend-bearing assets pay you on a regular basis no matter if your investments are gaining ground or in the red.
Understanding dividend yield and how it works is the key to perfecting your dividend strategy so you can properly compare investment options.
Dividend Yield Definition
Dividend yield is a ratio that shows you how much income you earn in dividend payouts per year for every dollar invested in a stock, a mutual fund or an exchange-traded fund (ETF).
To put it another way, dividend yield is a security’s annual dividend payment expressed as a percentage of its current price. This percentage yield tells you what your annual return on investment would be at the price you paid for the security.
Thanks to the power of compounding, reinvesting your dividends—rather than cashing them out—can significantly boost your returns, which is another reason why understanding how dividend yield works is so important.
A high dividend yield can be appealing since you’re getting more income per dollar invested, but a high yield isn’t always a positive thing. It could mean that the company’s stock price has been falling or dividend payments have been increasing at a higher rate than the company’s earnings.
How to Calculate Dividend Yield
To calculate dividend yield, divide the total annual dividend amount of a stock or fund in dollars by the price per share.
Dividend Yield = Dividends Per Share / Price Per Share
Let’s say a public company’s share price is INR 50 $50, and it pays annual dividends equal to $1.50 INR 1.50 per share. To determine the dividend yield, divide the dividend amount per share by the price per share: INR 1.50 / INR 50 = 0.03.
Convert the decimal to a percentage, and you get a dividend yield of 3%. That means you would earn 3% in dividends per year from an investment in the company’s stock at this price—assuming the dividend payout remained unchanged.
You can find out what dividends the company paid per share by visiting the company’s investor relations page and reviewing its financial statements. You can also see the dividend history of major companies on the Nasdaq dividend history tool.
To simplify your calculations, look at the annualized dividend payouts. You can usually find that information in the company’s annual report (10-K filing), its most recent dividend payout statement or using the trailing dividend method, where you add up the four most recent quarterly dividends to determine the annual dividend.
What Affects Dividend Yield?
There are many factors that impact dividend yield, like overall market conditions, individual stock and fund prices, and company performance.
Stock Prices
The biggest factor impacting dividend yield is a company’s stock price. When share prices rise, dividend yields fall—unless companies choose to boost dividend payouts.
A declining dividend yield due to a higher stock price isn’t necessarily a bad thing. It could mean that investors are more confident in the company and view it as a better investment. And the appreciation you gain from a rising stock price can offset a lower dividend yield.
Industry Trends
When evaluating dividend yields, it’s important to compare the yields offered by companies in the same industry—or funds in the same category—since yields can vary greatly across sectors, industries and fund categories.
On the table below, we compare the average dividend yield for each stock market sector in December 2019, just before the Covid-19 pandemic struck, and in December 2020, almost a year after the pandemic had upset the global economy.
Some sectors, like consumer discretionary stocks, saw big declines in average dividend yields. With Americans quarantined at home and only spending on essentials, discretionary goods companies earned less and lowered their dividends.
Other sectors, such as energy stocks, saw higher average dividend yields. Disruptions to the global economy increased the price of energy, raising profits for oil and gas companies, which passed the gains on to their investors in the form of higher dividends.
Company Growth
Generally speaking, older, larger companies that are well established and have steady performance are more likely to pay dividends—and have higher dividend yields—than newer, smaller companies.
Growth stocks that are expanding exponentially and rapidly growing their earnings and revenues choose to reinvest profits rather than pay dividends. Dividend investors are much less likely to devote their portfolios to growth stocks for that reason.
Company Fundamentals
High dividend yields can be attractive, but sometimes they can be a sign that a company is facing problems. A higher yield can occur when the stock price falls due to a decrease in the company’s earnings or because of declining investor sentiment.
In some cases, struggling companies may increase dividends to boost yields and attract new investors. However, unless the company is able to turn itself around and continue to support elevated payouts, its dividends may not be sustainable.
What Is a Good Dividend Yield?
Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock’s yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
If you’re retired or you are approaching retirement age, you may be looking to build a portfolio of income-generating assets. Investors in this camp prefer dependable, sustainable dividend yields for the long term. Check out the dividend aristocrats, which are companies that have increased their annual dividend payments for at least 25 consecutive years.
Younger investors with longer time horizons may be less interested in dividend stocks or income investing. They might focus more on growth stocks, with the potential for price appreciation over time, and be better off with growth stocks.
Pay Attention to Dividend Yield
The dividend yield can play an important role in evaluating a stock’s return on investment, but it shouldn’t be the only factor you consider when choosing your investments.
To make sure your investments are sound for the long-term, look at dividend yield as part of the big picture, alongside other metrics like performance versus major benchmark indexes and corporate fundamentals.
If you’re focused on dividend investing to get steady cash flow over the long-term, check out our picks for the best dividend stocks.
