Before entering the world of trading, there are a few fundamental terms that you should get acquainted with. Understanding dividend yield will help you find stocks that offer the most opportunity, and help you understand the climate of the wider sector you’re investing in. Let’s take a closer look at this area, including how to calculate dividend yield and how this information can inform your next steps.
What is a dividend?
A dividend is the amount of money a company pays to shareholders per share. Dividends are typically released either quarterly or annually to any shareholder who is holding stock by a specific deadline known as an ex-dividend date.
The dividends paid out are a portion of the company’s profits, and they’re essentially a reward to the shareholders who help keep the business afloat. Dividends are never guaranteed, and whether or not they’re given out is at the discretion of the company – though it’s unlikely for a company that has long offered dividends to stop doing so without good reason.
Dividends are based on a single share, so if, for example, you have ten shares in a company that makes a good profit and offers a dividend of £40 per share, you’ll receive £400 in dividends. The higher the dividend, the better, as this means you’ll earn more on your investment.
What is dividend yield?
Dividend yield is a financial ratio that estimates how much a company will pay out in annual dividends, relevant to stock price. Dividend yield is displayed as a percentage that represents the ratio between dividend and stock price.
Generally, the dividend yield will rise as the price of the stock drops and vice versa, presuming the dividend itself remains the same.
How to calculate dividend yield
The dividend yield formula is very simple:
Dividend Yield = Annual dividend Per Share / Market Value Per Share
Dividend yield is an annualised figure, so if a company pays dividends quarterly, you’ll need the sum of each quarter’s payments before using this dividend yield formula.
For example, if a company offers stock at £60 per share, and over the year pays quarterly dividends of £0.2 per share, you’ll work out dividend yield by doing the following:
Annual dividend share: £0.2 x 4 = £0.8
Market value per share: £60
Dividend yield ratio: £0.8 / £60 = 0.013
Dividend yield as a percentage: 0.013 x 100 = 1.33%
This means that through dividends, you would earn 1.33% on shares you own in that company. If the market value of a share dropped to £40, the dividend yield ratio would then become 2%.
Understanding dividend yield ratio
Dividend yield can depend on a number of factors. For one, the stature of a company might play a part. Younger companies that are growing rapidly might refrain from offering high dividends, or any dividends at all, so that they can reinvest that profit for further growth.
Meanwhile, a mature company which is finding it difficult to achieve growth might present a higher yield to attract larger investment. You wouldn’t be able to say whether a company is a good or bad investment based on dividend ratio alone, but you can use dividend ratios to help guide your investment strategy and to measure which shares might offer the best opportunity based on your income goals.
Dividend yield can also vary depending on the sector or industry you’re investing in. For example, oil and gas companies have an average dividend yield of about 4.92%, while the consumer goods sector – like food, drink and tobacco companies – average a dividend yield of 2.22%. Consider the average dividend yield for any sector, and use this to help you identify areas of opportunity.
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