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How to Calculate the Yield on Stocks that Pay Dividends

pfincome | May 14, 2010 |

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Investing in stocks that pay dividends is a way to build a solid set of assets that can provide income for many years. Dividend stocks come in many different forms. Some of them pay quarterly dividends while other stocks pay on a monthly basis. Some companies, like an oil trust, like to payout the majority of their earnings in dividends. On the other hand, blue chip companies that are more stable tend to payout much less of their earnings to investors leaving the rest to grow the company.

Many investors have made a career in investing in stocks that pay dividends. One important tool that these experienced investors often use is known as the dividend yield. On the surface, this calculation seems to be very straightforward and easy to calculate. However, the information that can be gathered from this value is unmeasurable. An interested dividend investor should educate themselves on the important of a dividend yield and how to calculate it.

Dividend Yield Calculation

Calculating a company's dividend yield is actually quite simple. The two pieces of data required to run the calculation can be found on most financial websites. The annual dividend yield of the company is the first piece of data that is required. Be sure to use the annual (12-month) yield instead of the quarterly or monthly dividend payment for the calculation. The second piece of data is the current share price of the stock.

An investor interested in calculating the dividend yield should follow the following calculation.

Dividend Yield = Annual Dividends / Current Share Price

Dividend Yield Example

An investor interested in calculating the yield of a popular dividend stock like Wal-Mart Stores, Inc. (WMT) would first find the annual dividend payment. Recently, the company's annual dividend was $1.21 per share. If the stock was currently trading at $50 per share, then the dividend yield would equal 2.4%.

The important thing to remember about calculating the yield on stocks that pay dividends is that it constantly fluctuates. Since the current share price is constantly moving up and down, the yield is adjusting along with it. If Wal-Mart's share price were to have closed at $55 per share the following week, then the dividend yield would equal 2.2%.

Using the Dividend Yield

Many dividend growth investors believe that a stocks yield should fall between 2% - 6%, give or take a few tenths of a percent. A stock with a dividend yield above 6% can be considered risky as it is hard for a company to maintain that level of payout. On the other hand, a yield of less than 2% is considered a low return on investment when it comes to receiving dividends. A more secure and stable investment like a certificate of deposit may offer a better return that is guaranteed.

It is important to note that an investors decision should not be solely based on a stocks dividend yield. Other factors such as dividend payout ratio, dividend history, and growth prospects are just as important information about a stock. Savvy investors use several key pieces of data to make their investment decisions when purchasing stocks that pay dividends.

Final Thoughts

Investors who want to build a solid portfolio of income producing stocks must understand what the dividend yield means. The calculation is actually very easy to perform and most financial websites already provide this data for free. Although the dividend yield of a stock should not be the only criteria used to make an investment decision, it is one of the most important. Combing the analysis of the dividend yield used in combination with other factors makes for a wise investment plan.

Full Disclosure - I currently do not own any shares in Wal-Mart Stores Inc. (WMT). The dividend yield calculations were for presentation only.