Dividend is the distribution of profit among the shareholders. Dividend Yield (DY) is the ratio of annual dividend received and the current price per share. It is a financial ratio which shows the amount of cash flow received for each dollar invested in the stock and is expressed in percentage.
For example, a company XYZ declares a dividend of $1 and the current market price of a share is $50. Therefore dividend yield of the XYZ is calculated as
Dividend Yield (DY) = ($1/$50)*100 = 2%
Dividend yield is the one of the factors which is considered before investing in a particular stock. Usually a stock with high dividend yield is preferred. For investors looking for minimum stream of income can invest in a stock with high and stable dividend yield.
For example, Company A and Company B each declares $1 as dividend. Supposing the stock market price of A is $20 and B is $40, the dividend yield of A is 5% and B is 2.5%. One would therefore invest in A as the dividend yield is higher, all other factors remaining the same.
Not necessarily all companies would pay dividend, that does not mean the stocks of those company is not worth buying or the company is not doing well. Growth oriented companies would pay fewer dividends or no dividend and invest the profits in projects which would benefit the company and the shareholder at large. Well-established companies tend to pay higher dividend.
Investors should not make their investment decision solely on the basis of dividend yield as this can risky. Taking the example stated above, Company A and Company B each declares $1 as dividend when the market price of Company A is $20 and B is $40. Assuming that the market price of Company B falls to $10 by the end of the year. The dividend yield of Company A stands at 5% whereas dividend yield of Company B has gone up to 10%. The dividend yield of B has increased because it failed to meet the earnings projection and the share price went down, which is not a good. Therefore, one would be putting his/her money at risk by investing in Company B.
It is advisable to check the financial of the company especially the payout ratio. A higher payout ratio is a cause of concern as it could mean that the company is failing to re-invest the profits in the business. The dividend yield of DJIA and S&P500 is approximately 2.97% and 1.83% respectively.
