What is Dividend Yield?

Does a stock with a high dividend yield automatically make a great investment? Not necessarily, amongst other factors it depends whether you are already holding those shares or are about to purchase them.

Dividend yield is a financial ratio which is expressed as a percentage of how much a company pays in dividends each year relative to its share price. 

Dividend yield = annual dividend per share ÷ price of the share

If the share price is unchanged, the dividend yield will rise with an increase^(a) in the dividend (pence paid per share) and will fall^(b) with a decrease in the dividend paid. Conversely, if the dividend (pence paid per share) is unchanged, the yield will rise^(c) if the share price has fallen, and it will fall^(d) when the share price has risen.  And then there’s the scenario where both the share price and dividend (pence per share) have fallen but the net result is no change in the dividend yield, although the cash received by investor is lower^(e).

The same rationale applies to the dividend yield on a portfolio of shares. 

So be clear whether you are looking at the quoted dividend pence per share or the dividend yield. The arithmetic for the dividend yield is simple, but its calculation is also sensitive to changes in the denominator – the price – and could look comfortingly high for shares (or a portfolio of shares) whose price and dividend pence per share have both fallen sharply.

Investors for whom dividend income is important seek companies with dividend sustainability – they look for balance sheet discipline, a history of consistent profit growth, sustainable dividends and ideally, year-on-year growth in the annual dividend paid. They also take good notice of the pay-out ratio, i.e. the percentage of net income a company spends on dividends, and whether this can be maintained over the longer term.

Companies in the S&P 500 index with 25 years or more of consecutive dividend increases are termed “dividend aristocrats”. Colgate Palmolive, Caterpillar Inc (in the machinery business), Chevron, Exxon Mobil, Johnson & Johnson, McDonald’s and Raytheon (aerospace and defence) are some of the stocks in this elite group. It is, though, too early to tell if the impact of coronavirus changes this.