Dividend Yield: Calculation, Advantages and Disadvantages

Dividend Yield: Calculation, Advantages and Disadvantages

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Jaya
Jaya Sharma
Senior Executive Content
Updated on Dec 7, 2023 18:21 IST

Dividend yield assesses the quantum of earning by total dividends that investors make through investment in a company. This yield is expressed in percentage where it is calculating by dividing cash dividend per share to market price per share.

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Dividend yield is indicated as the ratio of the current dividend of the company to the current share price of the company. Any stock yielding at least 3%-4% should be chosen by investors to invest into. In this article, we will be discussing dividend yield in detail. 

Table of Contents

What is Dividend Yield?

Dividend yield refers to a financial ratio that shows returns to investors on investing based solely on dividend payments. It is expressed as a percentage indicating how much the company pays as dividends every year relative to the stock price. This yield is the estimate of the dividend-only return on stock investment. It holds an inversely proportional relationship with stock prices. When the price of stocks increases, the dividend yield will go down.

Calculation of Dividend Yield

It is calculated by dividing annual dividends per share to the price per share. It can be calculated from the previous year’s entire financial report. However, calculating the yield as the year passes on, it no longer remains as relevant as before. Since dividends are paid on a quarterly basis, investors often consider the last quarter’s dividend. 

Dividend Yield = (Annual Dividend per Share / Current Market Price per Share) × 100

Then, they multiply it by four and use the product as an annual dividend to calculate the yield. When the calculation is done after large dividend distribution, it gives an inflated yield. In case the dividend is paid on a monthly basis; then the yield will be too low. While deciding how to calculate yield, investors should consider the dividend payment history to decide on a method that gives the most accurate results.

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Let us now understand dividend yield in detail:

 

Importance

Calculating yield is an important concept for investors as it gives an estimate of the return that can be expected from investments in a particular stock. Overall, yield indicates interest in an investment opportunity. It allows investors to assess the future growth prospect of a company. When the dividend yield is high, it indicates that the company is paying out a significant portion of earnings as dividends. When the yield is low, it means that the company is paying out small amounts of earnings as dividends.

Factors Impacting Dividend Yield

A number of factors impact the dividend yield, including the following:

  • One of the main factors that impact the yield is the dividend policy of a company. Based on this policy, the earning distribution as dividends among shareholders is impacted. This is why a consistent and stable dividend policy is required to get a higher yield. 
  • Several conditions, such as economic cycles and interest rate impact dividend yields. When the interest rate is low, investors seek higher income sources, which drives up the demand for dividend-paying stocks and it raises their prices This lowers dividend yields.
  • Dividend yield also depends on the financial performance of the company. If the company’s cash flow is high and it is making profits, it results in a higher dividend payout. This results in a higher yield. 
  • Payout ratio refers to the proportion of earnings that are paid out as dividends to the shareholders. A higher payout ratio leads to a higher dividend yield, which also indicates that the company’s yield is out of its own pocket. Basically, the company is paying out a large portion of its earning. This prevents the company from using its earnings for reinvestment and growth. 
  • There is an inversely proportional relation between yield and stock prices. Suppose the dividend payment is constant; in such a case, when the price of stocks declines, dividend yield increases. When the stock prices increase, the dividend yield decreases in such cases. Investor sentiment and market volatility also contribute to stock prices fluctuation, which then influences dividend yield.

Companies Offering Highest Yield

Companies that offer the highest yield in India include the following: 

Company Dividend Yield (Past 12 Months) Change in Stock Prices (Past 12 Months)
INEOS Styrolution India Ltd 34% -40.28%
Vedanta Ltd. 26.5% -0.85%
IOCL 16.8% -22.13%
RECL 16% -19.56%
PFCL 11.33% -24.88%
NMDC 11.1% -8.25%
SAIL 10.6% 29.47%
BEL 4.25% 54.93%
NTPC 4.19% 10.41%
Union Bank of India 4.13% 1.77%

Advantages

It has the following advantages:

  • Indicator of financial stability: A company paying out dividends on a consistent basis indicates the financial stability of the company. Investors have the faith in the company’s capability to remain financially stable. 
  • Steady source of income: It is a steady source of income for investors. It is beneficial for investors who are seeking to earn passive income.
  • Potential growth: Low yield may also indicate that the company might be reinvesting its profit back into the business to boost future growth. It is an attractive investment option for investors that are seeking long-term capital appreciation.
  • Risk mitigation: It can be used as a measure to mitigate risks for investors. A company that consistently pays out a high dividend is seen as a safer investment as compared to a company with low or no yield. 

Disadvantages

The following are the disadvantages:

  • In case the dividend data is old or is based on erroneous information, the evaluation of a stock based on this information is incorrect. 
  • Sometimes high yield can be misleading since it may indicate a falling stock price instead of an increase in dividend payment. This indicates that the company may have financial difficulties, or the financial market may perceive the stock as less valuable.
  • The yield is only relevant for those stocks that pay dividends. Many companies reinvest their earning into businesses that pay dividends. Comparing the yields of dividends across various stocks is not always appropriate.
  • Dividend yields are based on historical records of dividend payments that may not accurately reflect the future dividend policy of a company. 
  • The income via dividend is taxed at higher rate than capital gains, which can be disadvantageous for investors that come in higher tax brackets.
  • In the case of yield, investors overlook factors such as financial health, investment potential and growth prospects.

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FAQs

What is considered to be a good dividend yield?

When the dividend yield is above 3%, it is considered a good dividend yield.

Are dividend taxable?

Ordinary dividends are taxable as ordinary income. Qualified dividends must meet some requirements, only then, they are taxed at lower capital gain rates.

What does a high dividend yield signify?

High dividend yield indicates that the stock is providing high level of income relative to the current market price. A high dividend yield results in the declining stock price that may signal at the financial distress or less favourable outlook for the company.

Are dividends considered to be high risk?

In most cases, dividends are low volatility investments but one must know which companies offer the best yield.

About the Author
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Jaya Sharma
Senior Executive Content

Jaya is a writer with an experience of over 5 years in content creation and marketing. Her writing style is versatile since she likes to write as per the requirement of the domain. She has worked on Technology, Fina... Read Full Bio

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