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A dividend yield is a formula that shows how much is paid out by a company in dividends, as compared to its market price. In most cases, this formula is based on the annual dividend. The dividend yield helps determine which stocks are attractive to investors who prefer to make money through dividends. Investors can buy more shares of a stock if it has a lower price, but a higher yield in annual dividend payments.
To determine what the dividend yield will be, one must first determine what the dividend is. Most companies announce dividends quarterly, so to determine a price it may be necessary to add them up over the course of a year. Once the annual dividend payment is known, that number is divided by the stock price. For example, if the annual yield is $10 US Dollars (USD), and the dividend is $1 USD, the yield is 10 percent. A yield this high is very good with very few stocks outperforming it, but stocks can yield as much as 20 percent in some cases.
The price/dividend ratio is very important for some investors, but not all. If investors are trying to make money from the dividends, rather than simply trading, then a $10 USD stock with a dividend of $1 USD is much more attractive than a $20 USD stock with a dividend yield of $1 USD, because the ratio with the latter stock is only five percent. This is because, for the money, twice as much stock can be purchased for the same amount of dividend income.
While not all investors focus on the dividend yield as a money-making venture, it may help determine how healthy and profitable the corporation is. A high yield often indicates the company is making substantial earnings per share, but is not the only indicator. Some companies that have more stock issued may have a lower yield, but could still be very healthy. Therefore, it is important to take all circumstances into account.
The yield is also one way to identify trends. If the ratio continues to climb, then there is a good possibility the company is continuing to perform well. The opposite may also be true if the yield is falling. At the same time, the ratio could be falling for other reasons, such as another stock issuance. Investors should do their research into all possible explanations before making a firm conclusion based on the dividend yield.