What is Dividend Yield?
- 16 Oct 2024
- By: BlinkX Research Team
Open Demat Account
The dividend yield is a financial ratio that shows how much a company pays in dividends each year relative to its stock price. It is calculated by dividing the annual dividend payment by the current stock price. When the price of stock declines, dividend yield may increase. On the other hand, it will decrease when the stock price increases. Let’s find out what is dividend yield in share market, how dividend yield helps investors identify suitable investment options, its benefits, and more in this article.
How to Calculate the Dividend Yield?
To derive the dividend yield, the following formula can be used:
Dividend Yield = Annual Dividends Per Share / Price Per Share
To determine an appropriate method and find out what is dividend yield in the share market, consider the historical dividend pattern of a company. This is because quarterly dividends within the year are accounted differently for companies that pay monthly dividends. Moreover, it is necessary to consider the method of estimating dividend income that represents the company's dividend position at present appropriately.
Table of Content
- How to Calculate the Dividend Yield?
- Example of Dividend Yield
- Why Is Dividend Yield Important?
- What Factors Affect Dividend Yield?
- Advantages and Disadvantages of Dividend Yield
Example of Dividend Yield
Let's take the dividend yield example of two companies.
Company X pays ₹2 per share annually, and its share price is ₹50. Company Y also pays ₹2 per share value, but its shares are trading at ₹100.
Now, to see which company provides better returns, we compute the dividend yield using the formula mentioned earlier:
The dividend yield formula is: Dividend Yield = Annual Dividends Per Share / Price Per Share
Therefore, as per the dividend yield formula, the calculation will be:
- Company X: 2 ÷ 50 = 4%
- Company Y: 2 ÷ 100 = 2%
Company X has a better dividend yield of 4% as compared to 2% of Company Y.
If a person is looking for periodic returns on their investments, they may go for Company X. It offers better returns as compared to Company Y for an equivalent amount of dividend.
However, It is advisable to evaluate the potential of the company before investing.
Why Is Dividend Yield Important?
The following are some reasons that explain why dividend yield is important.
- Regular Income: Most investors, particularly those seeking consistent returns over a short period, consider dividends to be important. Dividend yields offer an easy way of making funds, which is useful when an individual retires. Investors can also choose to hold onto their dividends, reinvesting them and buying more shares of the company over time.
- Investment Comparison: Investors are always in search of investment ideas and research of dividend yields of several companies. This helps them discover better opportunities for investments. However, it is more appropriate to assess other aspects other than just dividend yield benefits.
- Financial Indicator: A better dividend yield may also indicate that the firm is performing well. However, this is not always the case, especially if the high dividend yield causes excessive gains to be shared with shareholders rather than used for business expansion.
What Factors Affect Dividend Yield?
A dividend yield is usually affected by various factors. This includes the following.
Company Growth Stage
Occasionally, the larger firms tend to pay higher dividends. Such firms usually have stable income, and hence they easily share a larger percentage of their gains with their shareholders. On the contrary, small firms are highly focused on business expansion and often do not pay dividends. Instead, they reinvest their gains back into the business.
Company Health
Even though the potentially high dividend yield ratio may seem appealing, it may not be an appropriate indicator. A high yield may sometimes be due to a reduction in the share price of the stock. This may point out problems in the company. Therefore, if the company remains in such a difficult position, sustaining such high dividend payouts will be difficult.
Share Price
The share price has the greatest impact on the dividend yield among all the factors. Unless the company is willing to increase the amount of the dividend, dividend yields tend to decline as share prices increase. An increase in stock price results in a decline in dividend yield.
Trends Across Industries
There are variations in trends across different industry sectors; therefore, dividend yield should ideally be analyzed and compared within the context of the same industry. Meaning, dividend yields can differ significantly among industries due to specific economic events and conditions.
For instance, firms in certain industries like energy may prefer to hike dividends as they have higher revenue. So, they may offer a larger part of the earnings to their shareholders. However, companies that provide non-essential services during an economic recession may reduce their dividend payouts. This is because these firms have lower revenues due to less demand for their services, impacting their dividend yields.
Dividend Policy
Some companies have a policy of regularly increasing their dividends. This can make them attractive to investors who want a steady income from their investments. Often, such companies with increasing revenues can offer more dividends on shares.
However, sometimes a company has a growing income but will still prefer to retain the earnings instead of distributing them through dividends. Such instances are very common in fast-growing companies and affect dividend yield.
Advantages and Disadvantages of Dividend Yield
The following is the breakdown of several advantages and disadvantages of dividend yield.
Advantages of Dividend Yield | Disadvantages of Dividend Yield |
Boosts overall returns by adding to stock price gains | High yield may hide issues like falling stock prices |
Shows that a company is financially healthy and stable | May not be useful for comparing all types of stocks |
Builds investor trust in the company's future | Outdated or misleading dividend data can lead to investment mistakes |
Provides regular income | Past dividends don't guarantee future payments |
Reflects proper management and long-term planning | Using only dividends as a performance metric may ignore other important factors |
Conclusion
The dividend yield is considered a useful tool in the share market. It indicates how much one can earn by holding shares of a company. Companies that offer high dividends usually attract investors who prefer regular income. You can find the dividend yield ratio of companies on a stock market app. However, remember that a higher dividend yield may sometimes indicate a drop in stock price. Hence, investors need to consider the company’s current health, its future strategies, and the sustainability of its dividends. These factors, help investors make appropriate investment decisions.
