Table of Contents
What is Yield?
Yield, in finance terms, refers to the cash return generated by a security over a period of time. It only includes the additional income earned which flows as a direct benefit from holding the security. It does not include the profits made by virtue of price fluctuations.
Similarly, dividend yield refers to the dividend income earned by the shareholder as a percentage of the market price of the stock. Dividend Yield is a financial ratio that establishes a relationship between the dividend per share and the current stock price. The formula for Dividend Yield Calculation is given below:
Dividend Yield = Dividend per share/ Market Price Per Share * 100%
Dividend Rate Vs Dividend Yield
The concepts of dividend rate and dividend yield must not be confused with one another. They are actually poles apart and using one for another will render all calculations and assumptions futile.
For example, Pegasus Inc comprises of stocks with a nominal value of $1 each which currently trade at $20 on the stock exchange. The board of directors declared a dividend of 25 cents per share. The dividend rate is a percentage value of the nominal value of stocks at which a company declares the dividend. In the above example, dividend rate is ($0.25/$1*100% ) 25%. The dividend yield, as discussed is a percentage return on the current stock price. Therefore the dividend yield in the example stands at ($0.25/$20) 1.25%. It is apparent from the wide difference in the resultant numbers that the two concepts are indeed separate and satisfy different purposes.
Dividend Yield Calculation
We have gone through the basic formula for dividend yield calculation. However, things do not end there. Analysts require even more detailed and prescriptive information about a stock in order to make a buy or sell recommendation for it. Adequate number crunching goes into the process of determining whether or not the stocks are a worthy buy. Some of the tools are discussed below:
Forward Dividend Yields
Forward dividend yields seek to forecast the dividend yield for the coming year. This form of dividend yield calculation is more accurate if the company has already announced the dividends for a quarter or any other period. Analysts then annualize this dividend to compute the dividend yield for the forthcoming year. If the company has not announced any dividends for the current year, analysts may use the actual dividends declared in the most recent reporting period of the previous year. Analysts may forecast the forward dividend yield assuming the same dividend policy continues.
For example, the company in its current quarter announces a dividend of 50 cents. Then the analysts may assume for the policy to continue in the current year. The total expected dividend to be declared equals ($0.50 *4 quarters) $2. If the current market price is $15, the forward dividend yield equals ($2/$15) 13.33%
Trailing Dividend Yield
This method is the exact opposite of the forward yield method. In this form of dividend yield calculation, the actual dividend for the previous 12 months is compared against its relative stock price. In this manner, the shareholders can set a realistic expectation of the dividend yield in the coming time, irrespective of the share prices. This method is more accurate and gives a better picture of the company’s financial performance. The credibility of this method is higher since it uses actual and not forecasted figures.
For example, a company declares a dividend of 50 cents in Q1 and Q2 of the previous year. And it is followed by a dividend of $1 in Q3 and Q4. The stock trades at $30 on the exchange. The total dividend declared in the previous year equals ($0.50+$0.50+$1+$1) $3. Therefore the trailing dividend yield is ($3/$30 * 100%) 10%.
Comparision Table of Forward Vs Trailing Dividend Yield
|Forward Dividend Yield||Trailing Dividend Yield|
|Uses predictive forecasted numbers on an annualized basis.||Uses actual figures of the dividend declared in the previous year|
|Preferred method when the board has declared dividend policy for the current year||Preferred method when no information whatsoever is available regarding the current dividend policy.|
|It is forward Looking||It is backward looking|
|May not be accurate and actual yields may vary||Is perfectly accurate since based on actual data|
High & Low Dividend Yield Stocks
While we are on the topic of dividend yield calculation it is necessary to cover an essential branch of dividend yield analysis. The universe of dividend-paying stocks can be divided into high or low yield stocks. Having understood the concept of dividend yield calculation, we may now move a step ahead. The pattern in which a company pays dividends says a lot about itself. The shareholders and analysts must interpret these signals to grasp what the company wants to convey.
High Dividend Yield Stocks
Also known as income stocks these are famous for yielding a generous rate of return on investment. The investors who prefer these stocks are the ones who require a steady stream of income. Normally pensioners and retired citizens opt for these stocks owing to the regularity of their dividend payments. However what some investors fail to notice is that high yielding companies are very slow to grow. They pay out a considerable portion of their earnings in the form of dividends. They are left with little to no proceeds to plow back for the growth of the business. One seldom notices significant capital appreciation on such stocks. Established companies or companies in their maturity phase usually go for a higher dividend yield. Utility companies are an example of high yield stocks.
Low Dividend Yield Stocks
They are also known as growth stocks. Unlike its counterpart, these stocks do not announce high rates of dividends. However low cash flows from dividend paying stock does not always mean bad news. A company with stringent dividend policies may indicate that it is diverting the earnings to profitable projects. In the face of prosperous opportunities, a high payout of the dividend is equivalent to throwing away cash. Such companies invest heavily into expansion and development projects. Such projects supplement their bottom line generously in the long run. The investors in these stocks, therefore, reap their return in the form of capital appreciation. These are the stocks which go on to become multi-baggers. Investors of low yield stocks have larger risk appetite and are in a position to block an amount of funds for a considerable period of time.
CFA LI&II Curriculum (CFA USA)Last updated on : June 2nd, 2018