Key takeaways
- Dividend yield is the annual dividend per share divided by the current share price: $1 a year on a $20 share is a 5% yield.
- A trailing yield uses dividends paid over the past 12 months; a forward or indicated yield annualises the latest or expected dividend, so published yields can differ.
- Because price is in the denominator, a falling share price raises the yield; a very high yield can mean the market expects the dividend to be cut.
- The payout ratio, dividends per share divided by earnings per share, shows how much of profit the dividend uses; above 100% it is paying out more than it earns.
- For funds, the SEC suggests relying on total return and SEC yield rather than distribution rates, and warns about frequent return of capital.
Investor.gov defines a dividend as a portion of a company's profit paid to shareholders, usually on a fixed schedule. Dividend yield puts that payment in proportion to the share price, so you can compare a $3 dividend on a $150 share with a $0.50 dividend on a $10 one.
The formula
Wikipedia gives the standard definition: dividend yield is the ratio of a share's annualised cash dividend to its current market price, usually as a percentage.
Dividend yield = annual dividend per share ÷ current share price
Its example: a share priced at $20 paying $1 in dividends over a year has a dividend yield of 5%. The same ratio works at company level: total annual dividends divided by market capitalisation.
| Share price | Annual dividend | Yield |
|---|---|---|
| $150 | $3.00 | 2.0% |
| $10 | $0.50 | 5.0% |
| $40 | $2.00 | 5.0% |
Trailing, forward and indicated yield
Wikipedia notes that published yields are not fully standardised. Three common versions:
| Version | Dividend used | Example |
|---|---|---|
| Trailing | Dividends actually paid over the past 12 months | Four quarterly $0.25 payments = $1.00; at $20, 5.0% |
| Forward | A projection for the next 12 months, often the latest quarterly dividend × 4 | Latest quarter $0.30 → $1.20; at $24, 5.0% |
| Indicated | The most recently announced dividend, annualised by payment frequency | Announced $0.40 quarterly → $1.60; at $32, 5.0% |
When a company has just raised or cut its dividend, trailing and forward yields diverge, so two websites can show different yields for the same stock on the same day. Special one-off dividends are another source of difference: some methods include them and some exclude them, and including a one-time payment raises the yield above what the regular dividend alone would give.
Why a high yield can be a warning
Price sits in the denominator, so the yield moves whenever the share price does. Suppose a company pays $2.00 a year:
| Share price | Yield | What changed |
|---|---|---|
| $40 | 5.0% | Starting point |
| $25 | 8.0% | Price fell 37.5%; dividend unchanged |
| $25, dividend cut to $1.00 | 4.0% | The cut the market may have been expecting |
The 8% yield in the middle row looks generous, but it exists only because the price fell. Wikipedia notes that a high dividend yield can be evidence that a stock is underpriced, or that the company has fallen on hard times and future dividends will not be as high as previous ones. Wikipedia, citing MSCI, describes the pattern of trailing yields rising as prices fall and then declining when dividends are reduced or stopped as a "yield trap".
The payout ratio
The payout ratio asks how much of profit the dividend uses. Wikipedia defines it as the fraction of net income paid to stockholders as dividends, calculated as dividends per share divided by earnings per share.
| Dividend per share | EPS | Payout ratio |
|---|---|---|
| $2.00 | $2.50 | 80% |
| $2.00 | $1.60 | 125%: paying out more than it earns |
A payout above 100% means the dividend is larger than the earnings for the period, so it is being paid from something other than that period's profit. Wikipedia adds that when a company returns cash through buybacks instead, the payout ratio becomes less meaningful.
Yield is not total return
Wikipedia distinguishes dividend yield from total return, which combines dividend income with changes in market price. A 5% yield on a share that falls 20% in a year is still a loss overall. Reinvested dividends can compound, as compound interest explained shows, but only while the dividend and the share price hold up.
Fund yields and return of capital
Funds pay distributions, and the SEC's bulletin on them adds cautions:
- Distributions are not guaranteed, and you can lose money in a fund that pays them.
- A fund pays distributions from what it earns, such as dividends, interest and capital gains, and/or from return of capital: giving shareholders back their own money. A fund must send a 19(a) notice when it does this.
- The SEC suggests caution with a fund that consistently uses return of capital, which could be a sign it is paying more than it can afford.
- Rather than relying on distribution rates, look at total return and the standardized SEC yield.
ETFs versus mutual funds compares the fund types, and how dividends work explains the record and ex-dividend dates.
Learn to Trade Stocks Beginner, one of our education apps, uses virtual money for practice trades. The investing basics hub lists related guides.
Good to know
Frequently asked questions
How do you calculate dividend yield?
Why does the dividend yield rise when the stock price falls?
Is a high dividend yield good?
What yield should I look at for a fund?
Sources
- Dividend yield (opens in a new tab)Wikipedia — accessed
- Dividend payout ratio (opens in a new tab)Wikipedia — accessed
- Fund Distributions – Investor Bulletin (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
- Dividend (glossary) (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
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