Investor Ratios measure how attractive public limited companies are for current and future shareholders to purchase. Dividend Yield is one of them.
Buying shares in a company has the potential for two kinds of financial return. Capital gains can be made when the share price is rising – you buy when cheap and sell when expensive. In addition, companies pay annual dividends to shareholders – you get a part of the firm’s profit (unless profits are too low or losses are made).
Investor Ratios give an indication of the prospects for financial gain from both of these sources.
What does Dividend Yield measure?
Dividend Yield is ratio between Dividend Per Share and Share Price. It compares Dividend Per Share with Share Price.
Dividend Yield measures the rate of return in the form of a dividend a shareholder gets of owning one share at the current share price.
Dividend Yield measures the rate of return in the form of a dividend a shareholder gets of owning one share.
How to calculate Dividend Yield?
The figures for working out Dividend Yield can be found in Profit and Loss Account (P&L Account), The EDGAR System, the primary system for companies to file documents for The SEC (The U.S. Securities and Exchange Commission), Yahoo Finance, or any reliable stock broker:
| Dividend Per Share | |||
| Dividend Yield = | ━━━━━━━━━━━━━━━━━━━━ | x 100 | |
| Share Price |
Example for Dividend Yield
A company with 1,000,0000 Shares Outstanding that pays USD$2,000,000 in Annual Dividends pays A company with Share Price of USD$100 that pays USD$2 in Dividend Per Share on an annual basis has Dividend Yield of 2%. Dividend Yield of 2% implies that shareholders are earning 2% return on their investment of owning one share.
Comment
Dividend Yield is expressed as a percentage.
Dividend Yield is a widely used metric to determine whether the company is a good investment when it comes to Dividends. Investors will evaluate whether the company is a good choice when it comes to earning returns on investment.
This rate of return can be compared with other investments, such as bank interest rates and Dividend Yield of other companies that pay dividends. The result needs to be compared with previous years and with other companies in a similar industry. It is because investors may have different levels of optimism about the prospects for different industries. It would not be useful for investors using Dividend Yield as a basis for their investment decisions to compare a high Dividend Yield of a real estate investment trust to a technology company with a low Dividend Yield. Each industry has different earnings reinvestment prospects.
Increasing Dividend Yield. If the share price falls due to deteriorating prospects for the business, then with an unchanged Dividend Per Share, Dividend Yield will increase. If the directors propose an increased dividend, but the share price does not change, then Dividend Yield will increase. Potential shareholders might be attracted to buy shares in a company with a high Dividend Yield as long as the share price is not expected to fall in coming months.
A high dividend yield may not indicate a wise investment though. Dividend Yield could be high because Share Price has recently fallen as the market is concerned about long-term prospects of the company.
Decreasing Dividend Yield. If the share price rises due to improved prospects for the business, then with an unchanged Dividend Per Share, the Dividend Yield will fall. If the directors propose a decreased dividend, but the share price does not change, then Dividend Yield will decrease. Potential shareholders might not be attracted to buy shares in a company with a low Dividend Yield unless the share price is expected to increase in coming months.
How to improve Dividend Yield?
Improved Dividend Yield ratio means higher Dividend Yield as a percentage. Shareholders will now get higher rate of return in the form of a dividend of owning one share.
- Higher Dividend Per Share. The company achieves higher Dividend Per Share under two conditions:
- Higher annual Dividends. The company can increase the dividends paid out to shareholders. The directors should decrease the proportion of Retained Profit for future investment. In case increasing annual dividends is not possible, use alternative sources of finance. The alternative sources of finance may include tapping into Retained Profits from past years, selling assets, raising additional debt finance through long-term loans and bonds, and raising equity capital through issuing additional shares.
- Less Shares Outstanding. The company, especially companies rich in cash, should buy back its own shares from the owners. Decreasing the Number of Shares Outstanding will increase EPS (Earnings Per Share) as more Net Profit After Interest and TAX will be now allocated to each common share.
2. Lower Share Price. Prices in any market are determined by the laws of supply and demand, market momentum, customers’ mood and the amount of speculation. Therefore, share price of the company stock will mainly decline under the following conditions:
- Laws of supply and demand. Business performance deteriorates and investors choose to invest in better businesses. There are several signs which indicate that the business is performing worse than before. It has:
- Worsening Profit and Loss Account (P&L Account). Sales revenue is declining. Costs are rising, Interest payments are rising, TAX payments are high. And profits are declining or the business is making a loss.
- Weak Balance Sheet. Cash evaporates, debt grows, inventories increase, debtors increase and Liabilities equal to 100% of Equity (Short-term Liabilities + Long-term Liabilities – Cash = 100%).
- Troubles with Cash Flow. Cash Inflows are declining. Cash Outflows are increasing. Net Cash Flow is declining or its negative.
- Market momentum. When the overall market sentiment supports selling with following market trends. Negative momentum indicates a bearish trend pushing the price downward following others (so called herding strategy).
- Investors’ mood. In general, prices positively correlate with investors’ mood with higher asset prices linked with better mood. A negative mood state will make investors more pessimistic about the future, therefore less willing to make risky investment decisions, or pay higher prices. Numerous events can impact social mood such as war, natural disasters, health epidemic, the weather, results of important sporting events, etc.
- The amount of speculation. All the speculation that is happening against the company. Financial speculation of stocks that can drive stock price down includes selling and short-selling. With sellers of stock, they will sell, if they speculate that the market will decrease in value, or if a company’s stock price will decline.
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Investor Ratios are of particular interest to current shareholders and prospective investors who need to assess the rate of financial return on shares and risk when making an investment to buy the shares.
