Dividend yield ratio definition
/What is the Dividend Yield Ratio?
The dividend yield ratio shows the proportion of dividends that a company pays out in comparison to the market price of its stock. Thus, the dividend yield ratio is the return on investment to an investor if the investor were to have bought the stock at the market price on the measurement date. The ratio is used by investors to understand the extent to which a business has committed to pay dividends.
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Calculation of the Dividend Yield Ratio
To calculate the ratio, divide the annual dividends paid per share of stock by the market price of the stock at the end of the measurement period. Since the market price of the stock is measured on a single date, and that measurement may not be representative of the stock price over the measurement period, consider using an average stock price instead. The basic calculation is:
Annual dividends paid per share ÷ Market price of the stock = Dividend yield ratio
The outcome is expressed as a percentage.
Example of the Dividend Yield Ratio
ABC Company pays dividends of $4.50 and $5.50 per share to its investors in the current fiscal year. At the end of the fiscal year, the market price of its stock is $80.00. Its dividend yield ratio is:
$10 Dividends paid ÷ $80 Share price
= 12.5% Dividend yield ratio
Problems with the Dividend Yield Ratio
A problem with the measurement is whether you should include in the numerator only dividends paid, or also dividends declared but not yet paid. It is possible that there will be overlap in the measurement periods if you use both dividends paid and dividends declared. For example, a company pays $10.00 in dividends during the fiscal year, but then also declares a dividend just before the end of the reporting period. If you are measuring based on cash received, you should not include the amount of the dividend declared; instead, measure it in the following fiscal year, when you receive the cash from the dividend. Doing so is essentially using the cash basis of accounting.
This measurement is not useful when a company refuses to pay any dividends, preferring to instead plow cash back into the business, which presumably leads to an increased share price over time as the underlying business is perceived by the investment community to be more valuable.