Understanding how to use the dividend yield formula is one of the first steps income investors must learn in order to build a solid portfolio of stocks. The yield of a stock can offer us useful information, such as the return on investment that investors could expect to receive in dividend payments when dividend stock investing. The yield can also be used in combination with other formulas and ratios to help investors make decisions on when to buy and sell stocks.
What is Dividend Yield?
The yield, also called the current yield, is a ratio used to show how much money is paid out to shareholders in relation to the share price of the stock. The percentage result helps investors understand how much return on investment they could expect, assuming the company maintains its dividend. For example, a 3% yield on a $1,000 investment could mean a dividend payment of $30 over the course of one year.
The Dividend Yield Formula
A company’s current yield can be found on most financial websites fairly quickly. However, in order to fully understand the results for your dividend investing, it helps to use the dividend yield formula to see where the numbers are coming from. The following equation can be used to calculate the return on investment (or yield) for a stock:
Yield = Annual Dividends Per Share / Price Per Share
As shown in the dividend yield formula above, there are two inputs to the equation. The first is the annual dividends per share, which includes any distributions paid in the past 12 months (regardless of calendar year). Most companies pay a quarterly dividend, which means there will be four payments that need to be summed to calculate the annual dividends per share. A smaller number of companies pay monthly distributions (or 12 times per year) and a few actually make one annual payment.
The second input to the formula is the price per share of the stock. Keep in mind that the current yield of a stock is constantly changing throughout a trading period, as it uses the current share price of the stock.
Using the Dividend Yield Formula
Let’s look at an example of how the dividend yield formula can be used by running the equation for Intel Corp. (INTC). At the time of this writing, the company had made the following dividend payments to shareholders over the past twelve months.
- May 2011 – $0.181
- February 2011 – $0.181
- November 2010 – $0.158
- August 2010 – $0.158
Based on the past four payments, we can calculate that Intel paid $0.678 per share in dividends in the past year.
The next step is to locate the current share price of the stock. At the time of this writing, the stock closed at $23.03.
Now that we have both of our inputs, we can quickly use the dividend yield formula to calculate the financial ratio.
Current Yield = $0.678 / $23.03
The results are a current yield of 2.94%.
Problems with Using the Dividend Yield Formula
As noted earlier, the calculated yield results are constantly changing with the rise and fall of the share price. For example, if the share price of INTC were to rise to $23.50, the current yield would actually drop to 2.89%. On the other hand, if the share price were to drop to $22.50, the yield would rise to 3.01%.
As you can probably tell by now, the current yield is not a static number and is constantly changing. Furthermore, the this calculation uses past dividend performance, which does not guarantee future results. The end result is a ratio that compares the current share price with past dividend performance which can provide misleading information.
This is not to say that the dividend yield is not a useful ratio to use, it is just something to keep in mind when analyzing stocks.
The dividend yield formula can help investors understand the type of return on investment they could expect if the company continues its past payments. The formula calculates the yield by taking the annual dividends paid to shareholders over the past year and divides it by the current share price of the stock. While there are some flaws with using a ratio like this, combined with other financial ratios and equations, the current yield should be a part of every investor’s tool kit for analyzing stocks.
Do you use the dividend yield formula to analyze investment opportunities?
Full Disclosure – At the time of this writing, I did not own shares of INTC.