Calculating a stock’s dividend yield is an important measurement for many income investors. This financial ratio lets investors know how much money a company is paying out each year in dividends based on the current share price of a stock. An investor purchasing $1,000 of a stock with a return of 5% can easily calculate their return on investment when it comes to dividends.
While understanding a company’s dividend yield is important, it should not be the only piece of financial data used to find stocks to buy. Because this calculation uses a stock’s past annual dividend, the ratio is comparing the current share price against what happened in the past. As any experienced investor will tell you, what happened in the past is not always reflective of what will happen in the future.
Blue chip stocks that pay dividends tend to have a dividend yield between 2% – 6%. Other, more risky investments, can payout a yield that well exceeds 10%. Some stocks that are in financial trouble may even show a payout that exceeds 20%. The point is that investors need to understand how to calculate a dividend yield so they can understand what it tells them.
How to Calculate the Expected Dividend Yield
The yield on a stock is calculated by taking the annual dividend per share and dividing it by the current share price.
Current Dividend Yield = Annual Dividend per Share / Current Share Price
Dividend Yield Formula – Example
If a company has a current share price of $50 and paid out $2.00 in dividends per share over the past 12 months, they would have a current yield of 4% ($2.00 / $50.00).
If the stock price drops from $50 to $40, the current yield suddenly jumps to 5% ($2.00 / $40.00). An investor who doesn’t understand this formula may think this is an incredible buy (which it may be). The experienced investor, on the other hand, understands why the yield jumped with no real change to the fundamentals of the company. This valuable information can then be used to conduct additional due diligence on the stock.
Leveraging Financial Ratios
The dividend yield is widely accepted as an important financial ratio to income investors. Used wisely, calculating this ratio can provide essential details about the health of a company’s payout. If the equation is not fully understood, the results may provide misguided information which can be risky.
How often do you calculate the expected dividend yield of a stock?
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