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Check out the introductory post on dividends if you haven’t already done so.
The term “dividend yield” or even just “yield” is commonly used when referring to the dividend of a stock or a stock index. The dividend yield is the percentage which you get by dividing the annual dividend payments (total of all dividends for the year) by the stock price. Keep in mind that most dividends are paid quarterly.
Dividend yield = annual dividend / stock price
For example if we look at the Microsoft investor relations page, we can see that they pay a dividend of $0.11 per quarter which totals to an annual amount of $0.44. If the stock price is $25.72 then the dividend yield is:
$0.44 / $25.72 = 1.7%
The dividend yield of a stock is similar to an interest payment on a certificate of deposit – except that CDs are advertised with their “yield” otherwise known as interest rate rather than the actual payment dollar amount.
There is a large range of possible dividend yields so if you are looking at dividend stocks or ETFs, you should compare to similar types of investments and don’t just rely on the dividend yield to make your choice.
Can the dividend yield change?
One of the things to note is that because you are calculating the yield using the stock price, it will continually change with the stock price. If the stock price increases, then yield gets smaller and vice versa.
If you are looking for dividend stocks, it may seem tempting to look for stocks that have a higher dividend yield than other stocks. Here are two potential problems with a higher dividend yield
1) If it is the result of a dropping stock price then it could mean that the company is not doing well financially and might be about to lower the dividend.
2) Sometimes a company will keep increasing its dividend at a higher rate than its earnings which will eventually lead to a situation where the company might be paying out more in dividends than it earns which will lead to a dividend cut.