Dividend yield is an easy way to compare the relative attractiveness of dividend-paying stocks. It tells us the return we can expect by purchasing a stock vis-à-vis bonds, FDs, etc.
A popular yield based measure used to value stocks is the dividend yield. It allows investors to compare the latest dividend they received with the current market value of the share as an indicator of the return they are earning on their shares. Note, though, that the current market share price may bear little resemblance to the price that an investor paid for their shares.
Dividend Yield Formula
Dividend Yield = Latest Annual Dividends per share/Current market price per share
Dividend Yield is thus an easy way to compare the relative attractiveness of various dividend-paying stocks. It tells an investor the return he / she can expect by purchasing a stock and can thus be compared with other investments such as bonds, certificates of deposit, etc. Investors who look to secure some regular income from their investments can do so by investing in stocks paying relatively high, stable dividend yields.
For example, if two companies both pay annual dividends of Rs.10 per share, but company A’s stock is trading at Rs.200 while company B’s stock is trading at Rs.400, then company A has a dividend yield of 5% while company B is only providing an yield of 2.5%. In this case, if we assume all other factors are equivalent, investors looking to supplement their income would likely prefer company A’s stock over that of company B.
Mature, well-established companies tend to have higher dividend yields, while young, growth-oriented companies tend to have lower yield. Many fast growing companies do not have a dividend yield at all because they do not pay out dividends as they reinvest all the cash in expanding the business.
What to look for while analysing a stock’s dividend yield
A high dividend yield may be an indication of a stock’s current attractiveness. However this can be misleading, if not sustained. Look at the dividend paying history of the company of last 5 years. A track record of maintaining and/or increasing dividends per share over the years is one indication of sustainability of dividends. A consistent dividend payout ratio for a firm with stable growth offers better clues towards sustainability of dividends.
You may also like to learn more on yield-based and other valuation measures, as below.