Dividend yield
The dividend yield or the dividend-price ratio on a company stock is the company's total annual dividend payments divided by its market capitalization, or the dividend per share, divided by the price per share. It is often expressed as a percentage. Its reciprocal is the Price/Dividend ratio.
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Dividend payments on preferred shares ("preference shares" in the UK) are set out in the prospectus. The name of the preferred share will typically include its yield at par: for example, a 6% preferred share. However, the dividend may under some circumstances be passed or reduced. The yield is the ratio of the annual dividend to the current market price, which will vary.
Unlike preferred stock, there is no stipulated dividend for common stock ("ordinary shares" in the UK). Instead, dividends paid to holders of common stock are set by management, usually with regard to the company's earnings. There is no guarantee that future dividends will match past dividends or even be paid at all. The most commonly-cited figure for dividend yield is the historic yield which is calculated using the following formula:
For example, take a company which paid dividends totaling $1 per share last year and whose shares currently sell for $20. Its dividend yield would be calculated as follows: 
Rather than just using last year's dividend, some people try to estimate the next year's dividend and use it to derive a prospective dividend yield. Such a scheme is used for the calculation of the FTSE UK Dividend+ Index[1]. Estimates of future dividend yields are by definition uncertain.
Related measures
The reciprocal of the divided yield is the Price/Dividend ratio. The dividend yield is related to the earnings yield via:
- earnings yield = dividend yield * dividend cover, and
- dividend yield = earnings yield * dividend payout ratio.
Desirability
Historically, a higher dividend yield has been considered to be desirable among many investors. A high dividend yield can be considered to be evidence that a stock is under priced or that the company has fallen on hard times and future dividends will not be as high as previous ones. Similarly a low dividend yield can be considered evidence that the stock is overpriced or that future dividends might be higher. Some investors may find a higher dividend yield attractive, for instance as an aid to marketing a fund to retail investors, or maybe because they cannot get their hands on the capital, which may be tied up in a trust arrangement. In contrast some investors may find a higher dividend yield unattractive, perhaps because it increases their tax bill.
Dividend yield fell out of favor somewhat during the 1990s because of an increasing emphasis on price appreciation over dividends as the main form of return on investments.
The importance of the dividend yield in determining investment strength is still a debated topic. The persistent historic low in the Dow Jones dividend yield during the early 21st century is considered by some investors as indicative that the market is still overvalued.[citation needed]
Related Reference
- Cohen, R.D. (2002, November) "The Relationship Between the Equity Risk Premium, Duration and Dividend Yield" Wilmott Magazine, pp 84–97.
Dow Industrials
The dividend yield of the Dow Jones Industrial Average, which is obtained from the annual dividends of all 30 companies in the average divided by their cumulative stock price, has also been considered to be an important indicator of the strength of the U.S. stock market. Historically, the Dow Jones dividend yield has fluctuated between 3.2% (during market highs, for example in 1929) and around 8.0% (during typical market lows). The highest ever Dow Jones dividend yield occurred in 1932 when it yielded over 15%, which was years after the famous stock market collapse of 1929, when it yielded only 3.1%.
With the decreased emphasis on dividends since the mid-1990s, the Dow Jones dividend yield has fallen well below its historical low-water mark of 3.2% and reached as low as 1.4% during the stock market peak of 2000.
The Dogs of the Dow is a popular investment strategy which invests in the ten highest dividend yield Dow stocks at the beginning of each calendar year.
S&P 500
In 1982 the dividend yield on the S&P 500 Index reached 6.7%. Over the following 16 years, the dividend yield declined to just a percentage value of 1.4% during 1998, because stock prices increased faster than dividend payments from earnings, and public company earnings increased slower than stock prices. During the 20th century, the highest growth rates for earnings and dividends over any 30-year period were 6.3% annually for dividends, and 7.8% for earnings[1]
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