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When you invest in stocks, you want a return on your investment. One of the forms the company may choose to share the profits of the business with you, the shareholders, is by paying out a dividend. The dividend yield of a stock represents the return you are likely to receive on a periodic basis by owning the stock.
Dividend Yield Formula
To calculate dividend yield, just divide the annual dividend per share of the stock with the current stock price. The result when expressed as a percentage is the dividend yield of the stock.
Dividend Yield = (Annual Dividend per Share / Current Stock Price)
For example, the AT&T stock is currently priced at $41.81. It pays a dividend of $1.96/year. This dividend is actually paid in 4 installments, once per quarter, in the amount of $0.49/share.
The dividend yield of the AT&T stock (T) is $1.96/$41.81 = 4.69%
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The Dividend Yield is Not Constant
Most well established companies tend to continue to pay the dividends at a steady or a consistently increasing rate. So if the stock price does not change, the dividend yield will increase as the business makes and shares more profits over time. However, the stock price also changes constantly so the dividend yield changes with the change in the stock price all the time. It is advised that you do not concern yourself with minor ups and downs in the value of the dividend yield and rather take a long range perspective when evaluating potential investment.
Companies that consistently grow their dividends are called Dividend Growth Companies. Some investment strategies call for identifying companies that have increased their dividends every year for decades. The assumption is that since there is a history of consistent dividend increases, the company is likely to keep it up. However, this is a false assumption. There is absolutely no guarantee that company that has increased dividends in the past will continue to increase it in the future (or even keep paying them). A better reason to invest would be the fundamental strength of a company and their business.
Keep in Mind Not Every Company Pays Dividends Quarterly
Most investors are used to receiving dividends quarterly and therefore it is a common practice to take the amount of the dividend paid in the past quarter and multiply it by 4 to get the annual dividend rate when calculating dividend yield. However, there is no requirement that the dividend needs to be paid on a quarterly schedule.
A number of companies, specifically international companies, pay dividends on a semi-annual or annual basis. There are also some companies that pay a monthly dividend. Additionally, a company paying dividends twice a year may pay different amounts at the half yearly and the annual payment dates.
This is important to keep in mind as majority of the online financial sites are not able to handle the varying dividend payments and non-quarterly schedules and will give you an incorrect dividend yield value. You need to factor this when you analyze an investment.
High Dividend Yields are Good, Right?
Maybe. It depends on the particular situation of the company.
Normally, if you find a dividend yield in double digits, you should dig deeper and see why the yield is so high. These kinds of yields are not normal.
First, you need to figure out if the company can afford to pay a dividend this high. In some cases, the business may have taken a turn for the worse, and the company may be forced to cut the dividend in the future (it may still be a great investment, but not for the dividends that may have attracted you to this company in the first place).
In some cases though, the company can actually afford and is willing to support the dividend at a high level as it words through some temporary business issues. These could be rare opportunities to buy a very undervalued stock that pays you a sufficiently high dividend to wait for the business to turn around.
We will have more discussion of these types of opportunities and ideas elsewhere on the site.