What is Dividend Yield?

Want to earn passive income when you retire? Many investors accumulate dividend stocks to build up cash flow. Dividend-paying corporations reward long-term shareholders with steady dividend payments. Many of these same corporations hike their dividends every year. If you want to set cash flow goals and understand how much you can earn from dividend investing, the dividend yield can help. Every dividend-paying stock has a yield that reveals how much you can earn from your capital.

How Does Dividend Yield Work?

Dividend yield helps investors calculate how much they can receive in dividends. It measures the annual dividend payment based on the percentage of a stock’s market price. Investors can establish criteria that include a minimum dividend yield as a parameter.

How to Calculate Dividend Yield

The calculation for dividend yield is straightforward. You have to divide the annual dividend by the stock’s current price. Assume a stock trades at $100 per share and offers a $0.50 quarterly dividend. Since the quarterly dividend is $0.50, the annual dividend is $2. Here’s how you can calculate the dividend yield for this scenario:

Dividend Yield = Annual Dividend / Share Price

Dividend Yield = $2 / $100

Dividend Yield = 2%

You can modify the numbers based on changes to the annual dividend payment or stock price. 

What is a Good Dividend Yield?

A good dividend yield depends on what you want as an investor. Some investors aim for a 4% dividend yield to make the 4% retirement rule more feasible. However, a high dividend yield can become troublesome. Some stocks have high yields because the market doubts the corporation can maintain the dividend.

Some corporations have lower dividend yields but also generate higher returns. NVIDIA has an unimpressive 0.034% dividend yield but has returned over 600% for investors over five years. Investors have to assess how much they want to earn from their dividend portfolios and what level of risk they want to incur. 

Advantages of Dividend Yield

Dividend yields provide investors with several advantages. Here are some of the perks of focusing on this ratio:

• Passive cash flow: Dividend stocks continue to generate cash flow every quarter as long as the company can continue distributing them.
• Preserve your portfolio during retirement: Some people build up enough dividend income and then do not have to touch their portfolios during retirement. The dividend cash flow can cover living expenses.
• Know what you get for every dollar: If you put $100 into a 4% yielding stock, you know you will receive $4 per year from that stock. Your annual payment can increase because of dividend hikes and reinvestments.

Disadvantages of Dividend Yield

Dividend yields present several advantages, but it’s important to keep these factors in mind before honing in on dividend yields.

• You may miss out on opportunities: A stock that pays no dividend or has a yield below 1% will not look as attractive to a dividend investor. Some of these same stocks can outperform dividend stocks.
• Dividend yield traps can hurt investors: A stock yielding 10% isn’t always a steal. Some stocks are yielding 10% because investors do not believe the company can support the current dividend. A declining share price for a high-yield dividend trap can exceed the profits from dividend distributions.
• Dividend yields don’t show dividend growth: A dividend yield shows you how much you make if you make an investment right now. Investors should also look at a dividend’s growth rate over the past few years to gauge how their dividend payments will improve. A low-yield but high dividend growth rate can deliver higher distributions in the future than a high-yield but low dividend growth rate.

Key Factors that Affect Dividend Yield

The dividend yield is not a static number. This number fluctuates throughout the day.

Changes in Stock Prices

Changes in stock price impact the denominator of the dividend yield formula. If a stock’s price rises, the dividend yield will decrease. However, pullbacks will increase the dividend yield. For instance, if a stock pays an annual $5 dividend and the stock’s price falls from $100 to $90, the yield goes up from 5% to 5.55%. 

Trends in the Industry

Trends in the industry do not have an immediate impact on dividend yields. However, if companies face financial pressure from trends in their industries, investors can expect lower dividend yields. For instance, if an industry is in decline, companies may have to reduce or suspend their dividends to compensate. Many airlines canceled their dividends at the start of the pandemic to compensate for a dramatic reduction in travelers.

Company Growth

Some companies increase their dividend every year. These initiatives make shareholders feel more confident in the company and can signal good financial health. A higher dividend payment increases the numerator of the dividend yield equation. Every dividend hike increases the dividend yield.

Investing in Dividend Stocks

The dividend yield helps dividend investors determine how much they will receive if they put $100 into a stock. Some investors only buy stocks that have dividend yields within a designated range. Knowing this metric can help you find stocks that fit your portfolio objectives and increase your cash flow. Some dividend investors make monthly contributions to their portfolios and reinvest dividends in an effort to retire sooner.

Frequently Asked Questions