What is Dividend Yield
Dividend yield is calculated from dividing per share dividends paid by the company with the current trading share price. Dividend yield calculator below shows the yield is calculated.
Dividend yield formula
Dividend / Share Price = Dividend Yield
The yield shows investment income the investors would have received from owning the share. Market convention uses the annual dividend yield where the amount is either over the last 12 month (historical) or next 12 month number from management guidance or analyst forecast.
It is a easy way to recognize how much income is generated by the investment. While it is actual investment income yield that the investor receives over 12 month period. Investors should be conscious the amount is only a portion of the total earning of the company. The payout ratio shows how much the total earning the company made is returned to investors.
Dividend / Earnings = Payout ratio
Payout ratio and dividend policy
Companies with high payout ratio means that a large portion of the earning is returned to shareholders while a low ratio means a large part of company income is reserved for further investment or repayment of debt. The right payout ratio is conditional on individual company circumstances and industry norm.
For example listed property trusts traditionally pays out a large portion of its income as distributions.
Companies with attractive growth prospects would not have pressure from investors return capital as the cashflow generated is used to fund future capital expenditure or income generating projects. An example of this include XRO ASX.
For companies that are highly leveraged, financial prudence would call for cash generated by the business to repay debt. We are seeing this the ORG shares where the market is not pricing any dividend growth going forward.
Beware of High Dividend Yield Shares – There is no such thing as free lunch
A segment of the investment population loves high yield dividend stocks. But we are always cautious of high dividend yield shares as there is no such thing as a free lunch in the markets. Investors need to ask some critical questions when they see a company with a higher than expected div yield and they usually falls into these categories.
Future earning risk
Are the earnings sustainable that the earnings paid out can be maintained at the current rate? Usually the market is already a discounting a dividend cut where future earnings is forecasted to decline from current levels (see ASX WES)
Future write offs
Future asset write off is expected by the market which is related to future earning risk. If the company balance shows is asset heavy for example industrials and listed REITs, then the market is discounting the book value. Currently the banks are the prime target where earnings are expected to unable to support share yield and future write off is priced for future housing losses.