How to Calculate Dividend Yield and Understand It

Dividend Yield

A3 Compute dividend yield and explain its use in analysis.

Investors buy shares of a company’s stock in anticipation of receiving a return from either or both cash dividends and stock price increases. Stocks that pay large dividends on a regular basis, called income stocks, are attractive to investors who want recurring cash flows from their investments. In contrast, some stocks pay little or no dividends but are still attractive to investors because of their expected stock price increases. The stocks of companies that distribute little or no cash but use their cash to finance expansion are called growth stocks. One way to help identify whether a stock is an income stock or a growth stock is to analyze its dividend yield. Dividend yield Ratio of the annual amount of cash dividends distributed to common shareholders relative to the common stock’s market value (price)., defined in Exhibit 13.19, shows the annual amount of cash dividends distributed to common shares relative to their market value.

EXHIBIT 13.19 Dividend Yield

Dividend yield can be computed for current and prior periods using actual dividends and stock prices and for future periods using expected values. Exhibit 13.20 shows recent dividend and stock price data for Amazon and Altria Group to compute dividend yield.

EXHIBIT 13.20 Dividend and Stock Price Information

Dividend yield is zero for Amazon, implying it is a growth stock. An investor in Amazon would look for increases in stock prices (and eventual cash from the sale of stock). Altria has a dividend yield of 8.4%, implying it is an income stock for which dividends are important in assessing its value.

Point: The payout ratio equals cash dividends declared on common stock divided by net income. A low payout ratio suggests that a company is retaining earnings for future growth.