What is the Dividend Yield?

Key Points

• The dividend yield is a financial ratio capturing what a company pays out each year in dividends in relation to their stock price. 
• The dividend yield has an inverse relationship with the market price of the common stock. 
• This can be a measure for relative valuation- a higher dividend yield might suggest that a company is cheaper than its competitors. 
• However a yield that is too high might suggest that the company is not able to invest in growth opportunities. 

Dividend Yield Example

The Home Depot Inc (HD) was paying a quarterly dividend of $1.50 which comes out to an annual dividend payment of $6.00. It has since increased, a GOOD SIGN. On 3/20/2020, HD was trading at $152.20 a share during the Covid Panic Selloff which would give you a dividend yield of 3.95%. 

Important note, your dividend yield is actually your return on investment which you can calculate by taking the annual dividend payment/ common stock price.

6.00/152.20=3.95%

Regardless of what direction the stock price might move in the market, the company will continue to make dividend payments so long as they remain financially stable or as the board of directors seems fit.  

Non-cyclical, mature companies with robust Free Cash Flow(FCF) will historically pay higher dividends attracting investors who seek a passive form of income. 

Various retirement portfolios are composed of high paying dividend stocks to help individuals during their retirement years with living expenses. 

While these companies might not be growing revenue at a high rate, their business models are stable and will usually have a history of growing their dividend.  

Beware of the High Yield Trap

Investing into dividend paying stocks means you as an investor will most likely lean towards stocks with higher dividend yields. This is fine, but investors should be aware of high yield traps due to the inverse relationship between stock prices and dividends. 

If a company has a high dividend yield, it is important for you to check and make sure a decrease in stock price is not correlated to a negative outlook on the company’s earnings or their sector.

Sacrificing growth is not always necessary when it comes to selecting companies who pay an attractive dividend. Their yields might be lower but there are various companies who pay attractive dividends and are experiencing above average revenue and earnings growth. 

As a matter of fact, almost all sectors of the economy will hold attractive dividend paying companies.
Some of these companies will be found in various Blue Chip Growth Portfolios but can also be incorporated into a Dividend Growth Portfolio. It can be inclusive of names such as Microsoft, Visa, Mastercard, Apple, Costco, Medtronic and The Home Depot.