How to Calculate Dividend Yield?

Key takeaways

• The dividend yield is a financial ratio that compares the annual dividend per share with the current market price per share.
• It offers valuable information about the amount of dividends a company pays per unit of the share’s market value.
• A high dividend yield indicates that the company pays out significant dividends to its shareholders, while a low dividend yield may mean that it is reinvesting most of its profits in the business.
• Income-focused investors may prefer companies with high dividend yields, while growth-oriented investors may prefer the opposite.

Investors with a long-term outlook must factor in different parameters before choosing stocks for their portfolios. Among the many factors worth considering is the dividend yield, which offers insights into how much dividend you will earn per rupee of the share’s market price. In this article, we discuss the dividend yield formula and explain how to calculate the dividend yield for different companies.

What is the dividend yield?

The dividend yield is a financial ratio that tells you how much dividend is paid out per share for each rupee of its current market price. To find this ratio, you need to know the annual dividend per share and the current market price per share.

The annual dividend per share formula is simple. You need to divide the total dividends paid out in a financial year by the total number of outstanding shares. Check out the dividend per share formula here:

Dividend per share = Total dividends paid during the year ÷ Total outstanding shares

Then, you can use the above value in the dividend yield formula, which is given below:

Dividend yield = Annual dividend paid per share ÷ Current market price per share

This sums up how to calculate the dividend yield. If you want more clarity about using the dividend yield formula, let us consider a hypothetical example. Say a company with a current share price of Rs. 50 has 1 lakh outstanding shares and has paid annual dividends of Rs. 10 lakhs in a year.

So, if you want to know how to calculate the dividend yield ratio, this is how it works. You need to first use the dividend per share formula to find the numerator in the dividend yield ratio.

Dividend per share:

= Total dividends paid during the year ÷ Total outstanding shares

= Rs. 10,00,000 ÷ 1,00,000 shares

= Rs. 10

Then, you can use the dividend yield formula as shown here:

Dividend yield:

= Annual dividend paid per share ÷ Current market price per share

= Rs. 10 ÷ Rs. 50

= 0.20

Factors affecting the dividend yield

The dividend yield is affected by various factors. Some of these are evident from the dividend yield formula, while others may be more indirect. The main factors that influence this ratio include:

• Share price movements: The dividend yield ratio is inversely related to the share price of a company. The higher the share price in the market, the lower the dividend yield will be. On the other hand, a declining share price boosts the dividend yield.
• Overall profitability: The overall profitability of a company also affects its dividend yield. If a company has higher profits, it may also pay out higher dividends. This, in turn, can improve the company’s dividend yield.
• Dividend policy: The company’s dividend policy also matters greatly. Companies in the early stages of growth may reinvest their profits, leading to low dividend yields, while mature companies may pay dividends more frequently, leading to better dividend yield values.

Common mistakes in dividend yield calculation

Although the dividend yield formula is simple, there are some common mistakes that you should attempt to avoid, such as the following:

• Using wrong dividend values: Some investors may mistakenly use quarterly or interim dividends in the dividend yield formula instead of the annual dividend. This may lead to inaccurate yield values. So, ensure that you verify the annual dividend value using the financial statements and use it in your calculation.
• Including special dividends: Some companies may pay out special dividends or one-time dividends. Many experts argue that including these dividends in the dividend yield formula may lead to skewed results as such special dividends may not be sustainable in the future.
• Using incorrect share prices: The current share price is a crucial part of dividend yield calculation. Using an outdated or incorrect share price value will lead to inaccurate ratios that could skew your investment decisions. To further avoid errors in calculation, consider using a dividend yield calculator in your analysis.

Benefits of knowing the dividend yield

Knowing the dividend yield can be beneficial in many ways. The top advantages of calculating and utilising this ratio include:

• Investment comparison: You can compare dividend yields to evaluate different companies and sectors easily. This ratio helps you identify investment avenues that offer potentially higher returns in the form of dividends.
• Income planning: With the dividend yield ratio, you can also estimate the potential income from your equity investments more easily. This is particularly useful if you follow an income-based approach to your investments.
• Share value assessment: The dividend yield ratio can also help you assess if a company is overvalued or undervalued. A high dividend yield may be a sign that the stock is potentially undervalued. However, a low dividend yield could be a sign of overvaluation.