Dividend yield is simply the annual dividend divided by the current share price, expressed as a percentage. For instance, if the annual dividend is $0.40 and the current share price is $18.00, then the yield is: <math>$0.40/$18.00=0.0222=2.22%</math>
Note that dividend yield changes because of two things. First, the stock price goes up (yield drops) or down (yield increases). Second, the company increases the dividend (yield increases) or cuts the dividend (yield drops).
Dividend yield is an important part of your rate of return on an investment. If you purchase a stock that goes up by 8% in a year while paying a 3% dividend, then you've earned 11% on your money.
Personal dividend yield can also be increased if you reinvest any money received as a dividend into more shares of the company, even if they are fractional shares. If you do this, you'll receive even more dividend the next time. Keep on doing this long enough and you could end up getting in annual dividends the amount of money you originally spent to purchase the stock. 100% yield -- how cool is that? Of course, this is helped along by the company steadily increasing dividends as their earnings increase.
The size of the dividend yield is often tied to the industry. For instance, utilities have traditionally been steady payers of relatively high dividends while software companies have traditionally not paid dividends (for a "zero" yield).
However, there are categories of investments where the dividend comprises a major portion of the return from the investment:
- Real Estate Investments Trusts (REITs)
This type of corporate structure is set up in such a way that they are required, by law, to pay out the vast majority (>90%) of their taxable income to their shareholders.
Investors interested in income are likely to be interested in companies with high yields. However in normal times, most sustainable dividends are in the (approximately) 2% to 5% range. If the company you are looking at has a yield well above that range, especially if it is above 10%, look more closely to find out why. Companies with such a large dividend often cut it to preserve cash and you'll be stuck with a stock that might not be worth owning.