This is an all-in-one guide on how to calculate Dividend Yield Ratio with detailed analysis, interpretation, and example. You will learn how to use this ratio formula to assess a company's dividend performance.
Definition - What is Dividend Yield Ratio?
The dividend yield ratio is a valuation ratio that tells us the dividend that a company pays out to its investors relative to its share price.
Cash dividends are reported in the financial statements of the company. We divide the annual dividend per share by the market value per share.
It is often used by investors who are looking for continuous dividend income.
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Formula
You can easily calculate the dividend yield ratio by using the following formula:
If there is a high degree of fluctuation in the share price, you should take the average share price for the period.
While calculating this ratio, we add all the cash dividends paid out. Also, we need to annualize the dividend.
We multiple the quarterly dividend value by four (monthly dividend figure by 12).
To calculate the value for current year, we either take the previous year’s dividend yield or take the latest quarterly figure and annualize it.
Example
Company A paid $1,000 in dividends in the previous year. The firm has 400 common shares outstanding. The market price of one share of the company is $50.
Interpretation & Analysis
Investors can earn a return from stocks either by dividends or by stock appreciation. This ratio is important for investors who want a constant stream of dividend income from their shares.
A company with a higher dividend yield pays its investors more in the form of dividends as compared to a firm with a lower yield.
A firm’s dividend yield can change over time either in response to market fluctuations in its share price or because of change in the dividend policy of the firm.
As with most ratios, the insights we can draw from this value depend on the industry that the firm is working in.
High growth firms such as technology firms rarely give dividends.
On the other hand, firms operating in telecom industry generally pay high dividends as they often have limited growth opportunities.
Cautions & Further Explanation
Generally, investors want as high a yield as possible. But, a higher dividend yield ratio is not necessarily a good thing.
The value could have shot up due to a sudden decrease in the market value of the stock.
This may be an indicator of financial troubles. You need to find out the exact reason for the increase in the value of this ratio.
If it is due to financial troubles, then the hike in value could be temporary and the company might have to reduce the dividend amount in future.
You also have to ensure that the firm can sustain paying high dividends and that it is not paying too much of its profits to shareholders.
If a firm does not pay dividends, it could be possible that it is reinvesting that money in the business.
Thus, not paying dividends is not a bad thing if it is being done for the right reasons and the money is being put to good use.
