Dividend yield is a key metric for income investors. It tells you how much cash return you get from dividends relative to the stock price. Understanding dividend yield helps you build a portfolio that generates passive income. Let us explore how it works.
What is Dividend Yield?
Dividend yield is the annual dividend payment divided by the stock price, expressed as a percentage. It shows what percentage of your investment you receive back in dividends each year.
Dividend Yield = Annual Dividend Per Share / Stock Price x 100
If a stock pays $2 per year in dividends and trades at $50, the dividend yield is 4%.
Dividend yield changes as the stock price moves. When the stock price goes up, yield goes down. When the stock price drops, yield goes up (assuming the dividend stays the same).
How Dividends Work
Before diving deeper into yield, let us understand dividends:
What is a dividend?
A dividend is a cash payment that companies make to shareholders, usually from profits. Not all companies pay dividends. Many growth companies reinvest all profits back into the business instead.
Dividend frequency
Most US companies pay dividends quarterly (four times per year). Some pay monthly, semi-annually, or annually. When you see annual dividend yield, it includes all payments for the year.
Important dates
- Declaration date: When the company announces the dividend
- Ex-dividend date: You must own the stock before this date to receive the dividend
- Record date: The date the company checks who owns shares
- Payment date: When you actually receive the cash
Dividend Timeline Example
Company ABC declares a $0.50 dividend:
- Declaration: January 15
- Ex-dividend: February 1
- Record date: February 2
- Payment: February 15
To receive this dividend, you must buy the stock before February 1.
Calculating Dividend Yield
There are two common ways to calculate dividend yield:
Trailing dividend yield
Uses dividends paid over the past 12 months. This is the most common method and reflects actual payments.
Forward dividend yield
Uses the expected dividend for the next 12 months. This is useful when a company has recently raised its dividend.
Yield Calculation Example
Stock XYZ trades at $80 and pays quarterly dividends of $0.60
Annual dividend = $0.60 x 4 = $2.40
Dividend yield = $2.40 / $80 = 3%
For every $1,000 invested, you receive $30 per year in dividends.
What is a Good Dividend Yield?
There is no universal "good" yield. Consider these benchmarks:
- S&P 500 average: Around 1.3-1.5%
- Utilities sector: 3-4%
- REITs: 4-6%
- High-yield stocks: 5%+
Higher yield is not always better. Very high yields (above 6-8%) often signal problems. The stock price may have crashed, or the dividend may be unsustainable and about to be cut.
The Dividend Yield Trap
A high dividend yield can be a trap. Here is why:
Falling stock price increases yield
If a stock drops from $100 to $50 while paying a $4 dividend, yield jumps from 4% to 8%. But the stock fell for a reason, likely trouble at the company.
Unsustainable dividends get cut
Companies cannot pay more in dividends than they earn forever. If a company's earnings decline, they may cut the dividend, which usually causes the stock to drop further.
Warning sign: If a stock's dividend yield is much higher than its peers or historical average, investigate why before buying. Look at the payout ratio (dividends as a percentage of earnings) to see if the dividend is sustainable.
Dividend Yield vs. Dividend Growth
Investors often choose between two dividend strategies:
High yield strategy
Focus on stocks with high current yields (4%+). You get more income today but may have less growth. Examples: AT&T, Altria, utilities, REITs.
Dividend growth strategy
Focus on stocks with lower yields but consistent dividend increases. You get less income today but more over time. Examples: Johnson & Johnson, Procter & Gamble, Microsoft.
Growth vs. Yield Over Time
High yield stock: 5% yield, no growth
Year 1: $50 dividend on $1,000
Year 10: $50 dividend (same)
Dividend growth stock: 2% yield, 10% annual growth
Year 1: $20 dividend on $1,000
Year 10: $47 dividend (and likely stock appreciation too)
Dividend Aristocrats
Dividend Aristocrats are S&P 500 companies that have increased their dividend for at least 25 consecutive years. These are considered among the most reliable dividend payers.
Notable Dividend Aristocrats:
- Coca-Cola (60+ years of increases)
- Johnson & Johnson (60+ years)
- Procter & Gamble (65+ years)
- 3M (65+ years)
- Colgate-Palmolive (60+ years)
Dividend Kings have even longer streaks of 50+ years of consecutive increases.
Tax Considerations
Dividends are taxed differently depending on their classification:
Qualified dividends
Taxed at long-term capital gains rates (0%, 15%, or 20% depending on income). Most dividends from US companies held for more than 60 days are qualified.
Non-qualified (ordinary) dividends
Taxed as ordinary income at your regular tax rate. This includes REIT dividends and dividends from stocks held less than 60 days.
For tax efficiency, consider holding dividend stocks in tax-advantaged accounts like IRAs or 401(k)s.
Using Dividend Yield in Your Analysis
Here is how to use dividend yield effectively:
- Compare within industries: A 2% yield in tech might be high while 2% in utilities is low
- Check payout ratio: Dividends should be less than 60-70% of earnings for most companies
- Look at dividend history: Consistent increases are a good sign
- Consider total return: Dividend yield plus price appreciation equals total return
- Watch for yield traps: Very high yields often precede dividend cuts
Track Your Dividend Income
Pro Trader Dashboard helps you track all your investments including dividend-paying stocks. See your income streams and monitor your portfolio performance.
Summary
Dividend yield measures the cash return you receive from dividends relative to the stock price. While higher yields provide more immediate income, very high yields can be warning signs. Consider both current yield and dividend growth potential when building an income portfolio. Look at payout ratios and dividend history to assess sustainability.
Want to learn more? Read our guide on earnings per share or learn about dividend vs growth stocks.