Dividend yield is an important factor in determining the the true value of dividend stocks. This fact holds especially true when investors are seeking to derive dividend income from their investments.
What is a dividend yield and how do you calculate it?
Dividend yield is an easy way to compare the relative attractiveness of various dividend-paying stocks. It tells an investor the yield he/she can expect by purchasing a stock. To calculate the dividend yield, divide the annual dividend by the current stock price.
An Example: If company XYZ was trading for $20 per share and paid a $1 dividend, how much will the stock yield each year for the investor? Using our formula (Annual Dividend / Current Stock Price = Dividend Yield), we find the answer is 5%.
Beware: High-yield dividend stocks can be a trap!
An investor desiring to put together a portfolio that generates high dividend income should place great scrutiny on a company’s dividend payment history. Only those corporations with a continuous record of steadily increasing dividends over the past twenty years or longer should be considered for inclusion. Furthermore, the investor should be convinced the company can continue to generate the cash flow necessary to make the dividend payments.
If you look at the current sub-prime mortgage mess, companies are sometimes showing yields in the 10-20% range, but unfortunately that is because the stock press has been hit hard and they will inevitably have to cut those yields. So be careful when you are excited about jumping into a stock, just because the yield may be high.
Key Lessons in This Chapter
- Dividend yield is an important consideration for investors, since it represents the annualized return a stock pays out in the form of dividends.
- Investors looking for income from dividend stocks should concentrate on those with 5% or higher dividend yields.
- Stocks with a dividend yield of 10% or higher are very risky, since a dividend cut is likely in store.
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