How to Calculate Dividend Yield?

Dividend yield refers to the dividend income earned by the shareholder as a percentage of the market price of the stock. A dividend yield is a financial ratio that establishes a relationship between the dividend per share and the current stock price. But the question is “how to calculate dividend yield”. The basic formula for calculating dividend yield is given below:

Dividend Yield = (Dividend per share/Market Price Per Share) * 100%

How to Calculate Dividend Yield?

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 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 approaches to calculating dividend yield 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.

The formula to calculate forward dividend yield is as follows:

Forward Dividend Yield = (Future Dividend Payment/Current Market Price) * 100

For example, in its current quarter, the company announces a dividend of 50 cents. The analysts assume that the policy continues 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)*100 = 13.33%

Also Read: Dividend Yield

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 current market 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.

The formula to calculate trailing dividend yield is as follows:

Trailing Dividend Yield = (Total Dividend of Previous 1 Year/Current Market Price) * 100

For example, a company had declared a dividend of 50 cents in Q1 and Q2 of the previous year 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%.

Dividend Yield Calculation

Forward vs Trailing Dividend Yield

Forward Dividend YieldTrailing Dividend Yield
Uses predictive forecasted numbers on an annualized basis.Uses actual figures of the dividend declared in the previous year
The preferred method when the board has declared a dividend policy for the current yearThe preferred method when no information whatsoever is available regarding the current dividend policy.
It is forward LookingIt is backward-looking
It may not be accurate and actual yields may varyIt is perfectly accurate since, based on actual data.

Dividend Yield Analysis

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, some investors fail to notice 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 do not always mean bad news. A company with stringent dividend policies may indicate that it is diverting earnings to profitable projects. In the face of prosperous opportunities, a high dividend payout is equivalent to throwing away cash. Such companies invest heavily in expansion and development projects. Such projects supplement their bottom line generously in the long run. Therefore, the investors in these stocks reap their returns in the form of capital appreciation. These are the stocks that go on to become multi-baggers. Investors of low-yield stocks have a larger risk appetite and are in a position to block a number of funds for a considerable period of time.

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 stocks with a nominal value of $1 each, which currently trades 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, the 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.

Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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