Dividend yield is a fundamental concept for dividend investors. If you’re buying any dividend paying stock (or investment for that matter) you want to know what your yield is going to be.
Knowing what your expected yield will be and how to calculate it should become second nature.
I’ll show you what is a dividend, what is yield and how to calculate dividend yield.
A dividend is part of the profits a company pays out to shareholders if they have cash leftover. A public company or private company can pay dividends. Sophisticated investors might own stakes in private companies and receive dividends.
If you went into business with 2 people, all 3 of you would be shareholders in this private business. Yourself and the 2 others. Assuming at the end of the year there was some cash left over from running the business and the 3 of you decide to split the profits equally, then that would be a dividend.
A major point here is there needs to be cash left over for a dividend to be distributed. No profits should really mean no dividend. I say “should” because that’s not always the case!
The payout frequency can also vary. American companies payout every quarter, in Australia most compnaies pay out every 6 months. Some ETF’s will pay their distributions quarterly, or some companies will payout yearly. It all depends on the policy of the company or fund.
Yield as an investment term is worth understanding, you’ll hear that thrown around a lot.
The term yield can have many definitions, however the meaning we want to focus on is the “amount returned”. An easy example is when a farmer plants his crops. The farmer planted 100% of his beans but only managed to return 50% of those beans in the harvest. His yield (return) from the seeds he planted would be 50%
In the investing world, yield means the return from an investment. Looking at it another way, it’s also seen as how much money in the form of a cash via the dividend will be returned to me.
Once you put the 2 points together it makes sense, the dividend yield stands for the cash return you’ll receive from being a shareholder of that company. You might need to read over it a couple of times but once you understand it, it’s very simple.
How to calculate Dividend Yield
Now it’s time for some maths. I promise though the equation is easy to understand (even for someone like me who sucks at maths)
The information you need to work out your initial yield is, the yearly dividend per share (this means how much paid for every one share you own) and the share price you paid or think you’ll pay.
With that information the calculation is, dividend per share divided by the share price multiplied by 100. Dividend Yield is always expressed as a percentage
Dividend per share / share price x 100
Using Commonwealth Bank as an example. They paid an annual dividend paid per share in 2019 of $4.31, it’s closing price on May 22 was $58.70 a share. I’ll assume that’s the price paid. With that information the yield is:
($4.31 / $58.70) x100= 7.34%
You’ll notice my yield and the image above is different, that screenshot was from Yahoo Finance. Those investing information websites will usually factor in forward looking dividend payouts. From their analysis they’re assuming the dividend will be cut by 31 cents this year.
Once you have the yield, calculating the cash return is simple.
To calculate how much cash you’ll get returned from the investment, you need to multiply your planned investment amount by the percentage yield.
We’ll use $1000 as example. If I was to invest the whole $1000 into Commbank with a 7.34% dividend yield my cash return would be:
$1000 x 7.34%= $73.40
There you have it, an investment of $1000 with a 7.34% dividend yield would give you an extra $73.40 in your pocket at the end of the year.
Yield is always worked out the same, Planned investment or principal multiplied by the percentage.
I’ve got to add a side note. Don’t just go out looking for high yielding stocks. When a stock has an extremely high yield above the market average this means there could be something seriously wrong with the company and the dividend will be at risk of getting cut.
The market will beat down stocks they think is either going through a tough time or it’s future looks bleak. Lower share prices will create a higher yield. A company will always cut the dividend first when times get tough and they need to tighten up spending or reduce outgoing cash-flow.
Don’t be seduced by higher then average yields, do some research on payout ratios and fundamental analysis to see if it’s sustainable for the company to keep paying such a high dividend relative to the share price.
For example, Altria (NYSE:MO) manufacture and sells smokeable and smokeless tobacco products. They’ve always typically traded with a higher yield, however, their profits and cash flows are predictable due to the nature of the business so they can sustain a high yield.