What is a dividend yield?
Editorial staff, J.P. Morgan Wealth Management
- A dividend yield is a ratio showing the amount that a company pays in dividends compared to its stock price. To calculate a company’s dividend yield, divide its annual dividend per share by its price per share.
- Generally, companies that are mature, stable and not growing very quickly have high dividend yields. Companies that are smaller and fast-growing tend to have lower dividend yields.
- Companies with high dividend yields can be particularly attractive investments for people who are retired and rely on dividends for their income. For people with higher risk tolerance, other factors may be more important than dividend yields for evaluating investments.
Dividends are regular payments made by some companies to their shareholders. Businesses use dividends as a way to reward their investors and attract new ones by giving them a share of their profits. These dividend payments are usually made in cash, although they can also be paid as shares of stock or other assets. A company’s board of directors decides how and when dividends are paid. It’s important to keep in mind that not all companies pay dividends.
What are dividend yields and how do they work?
A dividend yield is a ratio showing the amount that a company pays in dividends compared to its stock price. If a company’s dividend payments stay consistent, the dividend yield rises when the stock price falls and falls when the stock price rises.
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Why are dividend yields important?
Dividend yields are a helpful metric for investors looking to identify stocks generating high income relative to their share price. These kinds of stocks can be attractive for investors looking to generate more income from their portfolio, such as retirees aiming to supplement their fixed incomes.
However, it’s crucial to understand that a dividend yield is only a snapshot of the potential return at a single point in time. Both components of the calculation – the dividend amount and the stock price – can change for different reasons. Stock prices can be volatile, and future dividends are not guaranteed.
If a company’s stock price has fallen due to some internal challenges, there’s added risk that it could cut or pause its dividend. Any company can choose to cut or pause its dividends at any time, and it’s important to make sure that the dividend yield hasn’t been inflated by a recent decline in the company’s stock price. If a company does reduce its dividend in response to financial distress, its share price could go even lower. For these reasons, it’s wise to research why a company’s dividend yield may seem particularly high, as it’s not always a positive sign.
How to calculate a dividend yield
Calculating a company’s dividend yield is slightly more complicated, and there are several approaches you can take. However, the two variables you will need to get started are its share price and annual dividend amount.
- To find a company’s current share price, look up its ticker on a financial website that provides up-to-date market information.
- To find a company’s annual dividend amount, look up its ticker on a financial website, check its Securities and Exchange Commission (SEC) filings or calculate the amount yourself by using the company’s income statement and balance sheet or dividing the total dividend amounts paid out by the number of outstanding shares.
The simplest way to calculate a company’s dividend yield is to divide its annual dividend per share by its price per share. To show this in action, if a company’s dividend payment is $1 per year and its share price is $20, it would have a dividend yield of 5%.
As for other methods on how to calculate the dividend yield, it’s a good idea to look at the company’s history of dividend payments to decide which method will give the most accurate results. Three additional options are to use the company’s most recent financial report, to look at trailing dividend payments or to leverage the company’s most recent quarterly dividend payment.
- Most recent financial report: You can calculate a company’s dividend yield using its most recent financial report. If it’s only been a few months since the company released its report, this data can be helpful. However, the data becomes less relevant as time goes on because the company’s performance, dividend strategy and other factors could have changed since the report was released.
- Trailing dividend payments: Another option when calculating a company’s dividend yield is to add up the total dividends paid over the past 12 months and divide it by the price per share. However, this method may not give the most reliable yield if the company has raised, cut or issued a special dividend in the past year.
- Most recent quarterly dividend: Yet another approach for calculating dividend yield is to take the company’s most recent quarterly dividend and multiply it by four, then use that number for the annual dividend when calculating yields.
Which companies have high and low dividend yields?
Generally, companies that are mature, stable and not growing very quickly have high dividend yields. However, it’s important to remember that not all companies offer dividends, and in turn, dividend yields.
Companies with high dividend yields
Here are some examples of companies that tend to have higher dividend yields:
- Consumer staples companies selling food, beverages and hygiene products often offer relatively attractive dividend yields. These companies are considered noncyclical, which means that their products are almost always in demand, regardless of how the economy is doing.
- Utilities companies providing services like water, electricity and natural gas generally have high dividend yields.
- Real estate investment trusts (REITs), master limited partnerships (MLPs) and business development companies (BDCs) usually have high dividend yields. For REITs and BDCs, this is in part because, under applicable tax law, in order to maintain their tax-advantaged status as “pass-through-like” entities, companies with these structures must distribute the large majority of their taxable income (i.e., at least 90%) to shareholders. This tax-advantaged status means that a REIT or BDC is not required to pay U.S. federal income taxes on profits that it distributes to investors as dividends. However, subject to certain exceptions such as for capital gain distributions, investors generally have to treat dividend payments from REITs and BDCs as ordinary income for tax purposes.
MLPs are typically treated as partnerships for U.S. tax purposes, and as such, MLPs generally do not pay U.S. federal income taxes on their income, while income, gain, loss and credit of the MLP “pass through” to the investors’ tax returns. To the extent that an MLP is treated as a partnership for U.S. tax purposes, distributions by an MLP can reduce an investor’s adjusted basis in the MLP and are not currently taxable to the investor to the extent of the investor’s adjusted basis in the MLP. Investors may want to consult with a tax professional when considering making an investment in a REIT, BDC or MLP.
Companies with low dividend yields
Of companies that offer dividend yields, those that are smaller and fast-growing tend to have lower ones. These companies may be reinvesting capital into expansion instead of paying dividends to investors. For example, many tech startups do not pay dividends at all when they are in their early stages, but investors may buy their stock with the expectation that they will grow and eventually pay dividends or simply because they are high growth.
The bottom line
Dividend yields offer investors a convenient snapshot of how much income a stock could provide compared to its current price, but they are just one piece of the decision-making puzzle. Relying on dividend yield alone can be misleading, since company performance, market volatility and changes in dividend policies all affect potential future dividend payouts. Mature companies or special investment structures like REITs, BDCs and MLPs often deliver higher yields, but every investor should carefully assess underlying risks before making investment decisions. Ultimately, investors should consider a balanced approach, factoring in dividend yield, company fundamentals and their own financial needs.
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Editorial staff, J.P. Morgan Wealth Management
