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Dividend Yield (DY)
A dividend yield ratio is a financial ratio that shows how much dividend you will get for the market value of one share of the company. It is expressed as a percentage of the stock price and calculated by dividing the dividend per share by the company’s market price per share. The dividend yield is used to compare the stocks that give dividends.
Understanding Dividend Yield with examples
Suppose a company named X gives Rs 40 dividend per share and another company Y, which also gives Rs 40 dividend per share. It is difficult to say here that for one share’s market value, which company has given more dividends. For this reason, DY is used.
DY = Dividend per share/Market price per share
Let’s assume the price of one share of X is Rs 1000, and the price of one share of Y is Rs 2000.
DY of X= 40/1000 x 100= 4%
DY of Y= 40/2000 x 100= 2%
It shows that company X’s shareholders have received more dividends than Y, i.e., if the market price of one share is Rs 100, the company is giving Rs 4 as a dividend. As the company’s market price changes daily due to the supply and demand, the dividend yield also changes daily. Because dividend, which is the numerator, remains constant, the price, which is the denominator, changes daily. Hence, the dividend yield will fluctuate daily. If the stock is very volatile, the dividend yield starts showing more due to the falling share price.
Suppose the share price of ABC falls to Rs 500 from Rs 1000 after one year. Then its dividend yield will rise from 4% to 8%.
Here the dividend remains the same. Just because the market price of the stock falls, the dividend yield rises from 4% to 8%. Therefore, while looking at the dividend yield, if it is high, check whether it is due to the company’s high dividend or due to the fall in the share price.
Understanding Dividend Payout Ratio (DPR)
The DPR measures the percentage of net income distributed to the shareholders in the form of dividends.
Dividend Payout Ratio= Dividends/Net Income
For example, if a company’s net income is Rs 10,00,000, it announced and issued Rs 1,00,000 of dividends to its shareholders. Then,
Dividend Payout Ratio= (1,00,000/10,00,000) x 100 = 10%
Keep the things in mind while looking at the dividend payout ratio. Firstly, always check the dividend payout ratio before the dividend yield ratio. Whenever the company’s dividend payout ratio is below 10, you should stay away from such companies because there is a risk of dishonest and fraudulent management. Secondly, if the operating profits come from non-core incomes or other incomes such as selling a factory or land, you should avoid such companies. As money comes one time, we call it a one-time dividend. The dividend should always come from the operating profits and not from the non-core incomes.
Key Takeaways
- Many companies pay a lot of dividends and have a high dividend yield, but they are not necessarily good companies.
- A high dividend yield company doesn’t need to be always better than a low dividend yield company. Sometimes companies do not pay a dividend at all, and they reinvest their entire profit to expand their business or improve the business operation. In this case, the company can grow a lot in the future and give you more dividends, and your probability of getting more dividends in the future increases.
Conclusion
When the dividend payout ratio of a company increases, it gives a strong and positive market sentiment that it is not just doing well; it is doing so good that it pays a higher dividend to its shareholders. The company which is stable, who do not have to spend anything for business in the future, the DY of those company remains high. If a company is earning a lot of profit but is not paying any dividends, it means that the company sees a lot of growth ahead.
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