If you want to generate a passive income from your share portfolio then the dividend yield is the most important financial ratio that you can use to identify dividend paying shares.
In this article, I’ll explain exactly what the dividend yield is, how to calculate a dividend yield and how to use it to find high dividend stocks for your income portfolio.
What Is A Dividend Yield?
As explained in a previous article, dividends are payments made by a company to its shareholders, similar to a bank paying interest on your savings.
The dividend yield is therefore what you get back each year, in return for what you invest.
The higher the dividend yield, the more cash you get back each year.
It therefore works like an annual savings rate for a savings account.
The dividend yield is just the way that investors express the dividend they receive each year.
Dividend Per Share (DPS)
To calculate the dividend yield for a share, you first need to know how much dividend has been paid per share for the latest year.
If the company only pays dividends once per year this is easy.
If it pays dividends twice a year, after interim and final results as most dividend paying stocks do, then you need to add these figures together.
If the company pays dividends four times per year, as some do, then the four payments need to be added together.
When you have done this, the total is known as the Dividend Per Share or DPS.
This dividend per share represents the dividend income received by the shareholder in the last year for each share that they own.
Dividend Yield Formula
Having calculated the dividend per share or obtained it from the company’s financial figures, the next step is even easier.
To calculate the dividend yield, all you have to do is divide the share price by the dividend per share figure and write it as a percentage:
Dividend Yield % = ( Share Price ÷ DPS ) x 100%
When you do this, just make sure that you have the share price and DPS figures measured in the same units.
Yes, you might think this is a bit rudimentary but it is surprising how easy it is to get this wrong, especially if you are rushing!
So take your time and make sure that if the share price is in dollars, then the DPS is also in dollars and not cents, pounds, pence or any other currency.
If you are in the UK, then share prices will usually be quoted in pence and DPS figures will also be provided in pence but not always!
It is increasingly common these days for stocks traded on the UK stock market to pay their dividends in US dollars, especially for gambling, oil or mining companies, for example, so beware.
Not all companies traded on the stock market pay dividends to their shareholders.
The ones that do are known as income shares, dividend shares, income stocks or dividend stocks.
The majority of dividend stocks have a yield of around the 2% or 3% area.
These companies are balancing the need to pay a dividend to shareholders with the need to invest in longer term growth of the company.
The ability of a company to pay dividends also depends on the ability of the company to generate cash as distinct from making a profit.
[Note that cash and profits are not the same thing but the subject is too big to go into now]
Some companies though produce more cash than they need to sustain and grow their business.
Also, some very large blue chip businesses have reached a happy medium where they can continue to grow at a steady controlled rate while paying out a relatively large dividend each year.
High Dividend Stocks
These companies have dividend yields that are above average and are known as High Dividend Stocks.
In the UK, dividend yields are particularly high at the moment, around the 6% to 8%+ mark, for FTSE 100 blue chip shares such as Aviva, RSA Insurance, GlaxoSmithKline, AstraZeneca and National Grid.
In the USA, dividend yields tend to be lower than in the UK but are still around the 4% to 5% mark for pharmaceutical stocks like Pfizer.
The thing you will need to be weary of though is that you may also find some stocks with ridiculously large dividend yields which are not what we want.
I’m talking now about shares with a dividend yield above 10%, say.
If you find one of these, the first thing you should do is to check its share price history for the last few months.
The chances are that the company is in trouble and its share price has fallen dramatically since it last paid a dividend.
It is also reasonable to expect that the company will be cutting its dividend soon to preserve its cash.
This will of course reduce its dividend yield but for the moment, the DPS figure being reported is for the last year’s results which are now out of date.
So when calculating a dividend yield or using it to pick high dividend stocks, make sure you are comfortable with the other information for the company too.
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