The term dividend yield ratio refers to a calculation that allows the investor-analyst to understand the return earned from stock dividends. The dividend yield ratio does not account for other benefits associated with stock ownership, such as stock price appreciation.
Dividend Yield Ratio = Dividend per Share / Price per Share
Return on investment measures allow the investor-analyst to understand the company's ability to provide shareholders with an acceptable return on their investment. This is usually assessed by examining metrics such as net worth, returns on equity or assets, earnings, economic value added, and dividends. Return on investment metrics provide analysts with a way to determine a fair price to pay for a share of common stock. One of the ways to understand the value provided by a company's dividend policy is by calculating their dividend yield ratio.
When an investor purchases a share of common stock, they become one of the company's owners. As such they are entitled to the earnings of the company. When a company generates profits, they can retain those earnings, they can use the money to fund capital purchases, or they can return some of earnings to shareholders in the form of a dividend. Calculating the dividend yield ratio allows the investor to understand the value the return of earnings provides.
The dividend yield ratio is a simple metric to calculate. Annualized dividend payments are divided by the current market price of a share of stock. This metric is often stated on a percentage basis. It's important to understand the dividend yield is not the only benefit an investor could derive from owning a share of stock since the price of the stock can also increase over time, providing an opportunity for a capital gain.
Company ABC provides investors with dividends four times each year. Over the last year, Company ABC paid four dividends of $0.23 each or a total of $0.92 per share. The average market price of a share of Company ABC's common stock over the last year was found to be $26.32. The company's dividend yield can then be calculated as:
= $0.92 / $26.32, or 3.5%