Dividend Yield
The dividend yield is a financial quotient which express the relationship between the dividend per share to market price per share sometimes expressed in percentage form. It portrays the extent to which a business pays out in dividends to the ordinary shareholders as market price of the ordinary share price changes.
This ratio is expressed as follows;
Steps of Computing Dividend Yield
Step 1
Determine the monetary value of dividend per share. This is achieved by dividing the total amount of dividends paid or declared and paid by the number of weighted outstanding ordinary shares
Step 2
Determine the monetary value of market price per share. This is achieved by dividing the total market capitalization by the number of weighted outstanding ordinary shares. This is if the market price is not directly provided.
Step 3
Establish the dividend yield ratio by dividing the outcome gotten in step 1 with the outcome of step 2
Example
Triple A co ltd paid a total of $20,000 dividends to its common stockholders by the end of 2016. The outstanding ordinary shares were 40,000 and the average market price per share for the whole year of 2016 was $2.
Required
i). Compute the dividend Yield for the company in the year 2016
ii.) Interpret the results
SOLUTION
i).
ii.) For every increase of the market price of the ordinary shares of the firm by 1 US Dollar, the management pays 0.10 US Dollars to the ordinary shareholders
Importance of Dividend Yield Ratio
1) Guideline to investors-dividend yield is a yardstick to advise portfolio managers on how to invest different age diversity investors’ funds. Such that for retirees, one should invest in those firms with high dividend yields for such companies favor the retired group. Unlike the youth who prefer firms with low dividend yield for them they focus on firm growth to benefit in the future
2) Balancing of benefits emanating from the markets dynamics-the management is able to pay more dividends as the market price of shares change positively so as to maintain the investor confidence
3) Indicator of product quality-the higher the dividend yield is a sign of good quality products the firm is supplying in the market and this pushes for increased dividends
4) Indicator of high performing firms-increased dividend yield ratio implies that the firm is performing well in the market and can weather bad times
Advantages of Dividend Yield Ratio
1) Investor is guaranteed of returns-firms with high dividend yield ratio is an indicator of good performance hence the investor will get returns every other financial period.
2) Motivator to invest the more-the investors are able to observe the fairness the management is practicing by increasing dividends as price level improves and this makes them invest more in such a firm
3) Yardstick to control firm activities-the higher the dividend yield ratio implies the firm is bettering in its performance and hence management can identify the firm’s areas of strength and put more efforts on the same so as to maintain competition and if the other way round, the management will use this ratio to identify its weakness and improve on that.
4) Financing tool-when firms pay more dividend as prices increase, this help in raising more capita/finances for more investors buy more shares
Disadvantages of Dividend Yield Ratio
1) Misleading in Stock Market Fluctuations: Due to temporary market ups and downs also, the market price of the share may increase or decrease. When prices decrease, the dividend yield ratio would increase and vice versa. So, you will have to make an adjustment for such fluctuations by taking the average of last 3 years prices so that it does not lead to faulty interpretation.
2) Insufficient as an Overall Return Metric: Also, dividend yield should not be the sole criteria to form an opinion on a company. There are some profitable companies in the market that do not pay dividends as they have profitable investment opportunities so they choose to reinvest their earnings. These stocks provide low dividend yield but they provide a better return on capital appreciation.
3) Dividend – a Compulsion: There are some mature companies which pay a higher amount of their earnings as dividends because they don’t have profitable reinvestment opportunities. These stocks provide high dividend yield but not necessarily a better return through capital appreciation. So only higher dividend yield does not mean that the company is doing well. You need to use other metrics and criteria for your analysis along with this.
4) High dividend yield ratio misinterpretation-sometimes high dividend yield may not translate to increased financial performance for sometimes firms borrow to pay dividends even other times they cook books to show that they are well performing. This act may mislead investors and lose money.
Dividend Payout Ratio vs. Dividend Yield
How are this two concepts related to one another? The following table portrays the difference
Difference between Dividend Payout Ratio and Dividend Yield Ratio
