What is a dividend yield?

Dividend yield (definition)

Dividend yield shows the dividends paid as a percentage of the share price. It’s a common measure of return on investment for shareholders.

Dividend yield helps potential investors identify which companies pay higher dividends relative to their share price. This number is especially important to investors who want cash income from their portfolio.

While dividend yield and profit are related, they’re different in key ways. Profit is the overall earnings of the business, but profits may not be distributed to shareholders. Dividend yield is concerned only with the value that is shared.

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How to calculate dividend yield

(Annual dividend per share/Current price per share) x 100 = Dividend yield %

Example of dividend yield calculation

A company pays an annual dividend of $2 per share and its current market price is $40 per share.

($2 / $40) x 100 = 5%

The dividend yield for investors is 5%.

Understanding dividend yield

While dividend yield offers insights into the income an investment might generate, it doesn't give you the full picture of a company's financial health or potential.

Stable or increasing dividend yields can mean a company is confident in its financial stability and future cash flow. However, dividend yield can be inflated by a declining share price, which may indicate the company is actually in decline.

Some companies will borrow money to keep dividends high. Or they’ll choose to pay dividends instead of reinvesting in the business. Both scenarios may undermine future performance of the business.

What’s a good dividend yield?

Dividend yields tend to fluctuate across industries and companies. Mature, stable companies with predictable cash flows often have higher dividend yields, while fast-growing companies in sectors like technology may have lower yields as they reinvest profits to grow market share.

A financial advisor will be able to suggest target dividend yields for an investment portfolio. Check out dividend yield by industry, from Forbes.

Limitations of dividend yield

Dividend yields don’t show capital gains that can result from increases in share prices over time. Capital gains are often a major source of returns for an investor.

As noted, dividend yields can also be inflated by declining share prices, or by a reliance on debt, which may ultimately diminish the sustainability of those yields.

The dividend yield should be just one measure in a broader analysis of a company’s health. A potential investor in a company should also consider its performance, profitability, liabilities, industry position, and growth prospects.

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This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.