Understanding And Calculating A Dividend Yield

To estimate the current income level from shares we can calculate the gross dividend yield (which means that it is calculated free of tax).

Where D0 = the dividend paid during period 0

and P0 = the share price of the stock at the end of time period 0

Gross Dividend Yield = D0 divided by P0

This may not be a useful guide to the likely future return from an investment in the company. As we know, there are two potential sources of financial return from a stock holding. The first is the the potential gain or loss from price movements. The second is the dividend yield. But this ratio only provides us with information about the income and not the capital. It is also worth noting that unlike a fixed income investment, the income stream may change. The directors may decide to increase or reduce payment and so D0 (shown above) may prove to be a poor indicator of the following year, D1.

There are also potential pitfalls when comparing the income streams yields of different companies. The management of the companies being compared may have entirely different opinions about the worth of paying out earnings to owners which will be reflected by differing policies.