Investing

Investing 101: Calculating Dividend Yield

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Whether you’re a seasoned investor or are just getting started, chances are you come across one investing term more often than others: dividend yield.

But while defining “dividend yield” is easy — the percentage of a stock price you earn from dividends, the portion of a company’s earnings usually paid out to shareholders on a quarterly basis – actually calculating a company’s dividend yield isn’t all that simple. 

To confuse matters, corporations declare dividends not as a percentage but as so much per share. For example, if a company declares that next year’s dividend will be $1.00 per share, everyone holding 100 shares will receive $25.00 once per quarter. ($1.00 x 100 shares = $100; and $100 ÷ 4 quarters = $25.)

To find the dividend yield, you must divide the dollar value of the annual dividend by the current share price. For example, if today’s price per share is $40 per share, the $1.00 per share represents a yield of: $1.00 ÷ $40 = 2.5%.

So if you buy shares today at $40 per share, you will earn 2.5% per year from dividends.

A few points to make about this:

1. If you reinvest dividends, you get 2.5% compounded. Each quarter, instead of receiving $25 in cash, you buy additional partial shares. If the stock price next quarter is still $40 per share, the dividend buys you 62.5% of one share. That might not seem like a lot, but it adds up over time.

2. The higher the stock price goes, the lower the current yield. For example, if the stock prices rises to $55 per share, that $1 per share is reduced to 1.8% ($1 ÷ $55 = 1.8%). However, you should calculate your yield based on the price per share that you paid when you bought stock, and not on what it becomes later.

3. By the same mathematical reasoning, when the stock price falls, the dividend yield rises. For example, if the price per share falls from $40 down to $32, the dividend yield rises to 3.125% ($1 ÷ $32 = 3.125%).

Anyone who tries to time the purchase or sale of stock to maximize dividend income should be aware of how those dates are figured. The ex-dividend date is the date on which stockholders of record earn dividends. Those dividends are not paid out until several weeks later. So before you buy or sell shares so that you will earn the dividend, find out when the ex-date occurs. If you buy after that date (or sell before), you will not earn the quarterly dividend.

The dividend yield should be a key ingredient in your evaluation of your portfolio and in the selection of companies whose stock you are thinking of buying. Some companies pay exceptionally high dividends and yet are considered very safe investments. This is not always the case, so if you just pursue the highest possible yield, it makes sense to perform a few fundamental tests first, and to determine whether or not it is safe to buy shares. Some the strongest and highest-rated companies (by Standard & Poor’s) include:

 Company

 Dividend*

 Altria (M)

 6.2%

 AT&T (T)

 5.9%

 H&R Block (HRB)

 5%

 Pfizer (PFE)

 4.6%

*as of January 1, 2011.

Never pick a stock based solely on dividend yield. But when all else is comparable, a higher dividend can work as a means for reducing your list of prospects.

Michael C. Thomsett is author of over 60 books, including Winning with Stocks and Annual Reports 101 (both published by Amacom Books), and Getting Started in Stock Investing and Trading (John Wiley and Sons, scheduled for release in Fall, 2010). He lives in Nashville, Tennessee and writes full time.

Investing 101: How to Calculate Dividend Yield was provided by Minyanville.com.