How to Calculate the Dividend Yield?

There are generally two reasons investors choose the equity market. The first is to benefit from the potential capital appreciation of the stocks in their portfolio. The second is to earn dividends from those stocks. Dividends are not guaranteed, but a company’s historical dividend payout track record can help investors assess the probability of earning a part of its profits. 

If you want to set up an alternative source of income through dividends, the dividend yield ratio can be a crucial evaluation tool. In this article, we take you through the meaning of this ratio, the dividend yield formula, how to calculate dividend yield and why this ratio is important. 

What is the Dividend Yield?

The dividend yield is a type of financial ratio that compares a company’s annual dividend payouts with its stock price. In other words, it tells you how much you earn as dividends on the shares you hold for each rupee you have invested in those shares. This definition makes it clear that the higher the dividend yield is, the better it is for the investor. 

To better understand how this ratio works and how it affects investment decisions, let us delve into how dividends work before discussing the dividend yield formula.

A Closer Look at Dividends and the Dividend Yield

In the initial stages of its business, a company primarily aims to turn profitable and grow quickly. So, most of the profits (if not all) are typically reinvested in the business to facilitate faster growth. However, after a company achieves a certain level of growth, its focus shifts to improving profitability and maintaining stability of operations. 

At this stage, many established companies may choose to distribute a portion of their profits to their shareholders. This is what we call dividends. Some companies may pay higher dividends than others. Some may pay dividends more frequently than others. So, choosing the right companies can be quite challenging if you want dividend-paying stocks, 

Here is where the dividend yield can be useful. When you calculate the dividend yield, you can estimate how much you can earn as dividends for every rupee invested. This will help you narrow down your choices and make an informed decision about which companies you can invest in. 

Dividend Yield Formula

The dividend yield formula is quite straightforward if you know what the ratio means. The formula shown here can help you calculate the dividend yield:

Dividend Yield = (Annual Dividend per Share ÷ Price per Share) x 100

The dividend yield formula shown above expresses the ratio as a percentage. You can also represent the dividend yield in absolute terms. 

How to Calculate the Dividend Yield?

Now that you have seen what the dividend yield formula is, let us check out how you can find this ratio. You can calculate the dividend yield by following these steps:

• Step 1: First, find the annual dividend paid by the company per share. 
• Step 2: Then, identify the company’s share price. The market price is considered for this purpose. 
• Step 3: Divide the dividend per share per year by the price per share and multiply the result by 100 to get the dividend yield in percentage terms. 

Calculation of the Dividend Yield Ratio: An Example 

Let us consider an example to understand further how the calculator of the dividend yield ratio works. Consider the following data for two companies and see how their dividend yield varies. 

As the examples above show, the dividend yield is very important. At first glance, you may think that Company 1 is better because it pays annual dividends of Rs. 1 crore, while Company 2 pays just Rs. 75 lakhs. However, calculating the dividend yield shows you that the first company offers dividends worth only 3.3% of each rupee invested, while the second offers over 23%. 

Why the Dividend Yield is Important for Investors

The dividend yield is important for investors due to various reasons. Here are some key benefits of using this metric in your investment decisions.

• Indicator of Income Generation

This ratio can indicate how much income you can expect to earn in the form of dividends from your investments. If you are a retiree or if you simply seek regular income to add to your primary income, a company with a high dividend yield may be able to offer the extra cash flow you require. 

• Insights About Investment Value

The dividend yield ratio also gives you valuable insights into a company's valuation. It can help you find potentially undervalued stocks. If the market price is less than the dividend paid, the stock may be undervalued and have scope for capital appreciation if a market correction occurs. 

• Better Risk Evaluation

With the dividend yield ratio, you can also assess the risk of an investment more effectively. A high dividend yield may suggest that the company’s market value has significantly dropped, likely due to financial stress. A stable yield, however, may indicate a less risky investment option. 

• Improved Return on Investment

The dividend yield ratio also adds to the total returns you can earn on an investment — which includes both capital gains and dividend income. Even if a stock does not appreciate much in value, a strong dividend yield can increase the overall returns earned, which is why investors must focus on total return strategies.

Also Read: The Power of Dividends: Compounding Wealth

Conclusion

The dividend yield ratio is an essential tool for investors focused on generating income from their equity investments. By comparing a company’s annual dividends to its stock price, this ratio offers a clear view of the potential returns that you can expect. Understanding how to calculate and interpret dividend yields can significantly impact your investment decisions, especially if you are aiming for a steady income stream.

If you are looking to enhance your investment strategies further, platforms like Motilal Oswal Research 360 provide a wealth of resources. This platform goes beyond basic data and offers detailed analyses of dividend yields, historical trends and other financial metrics. By integrating these insights into your investment plan, you can make more informed choices and ensure that your investments align with your financial goals while also tapping into potential high-yield opportunities.