Investing in stock markets can be done either through brokers or by the investors themselves. However, both modes require a great deal of research and analysis. Professionals or retail investors have to use many fundamental or technical analytical ratios or tools to know the correct value of the stock and its relative performance in the market when compared to its peers. This helps them decide when to enter or exit an investment to maximize their returns. One such analytical tool is the dividend yield ratio that is used to know the value of the stock in terms of dividend received.
Let us understand this concept better with the following details.
What is the meaning of the dividend yield ratio?
Investors of the equity market can get returns in two forms namely dividend and capital gains. While capital gains occur only when the investors sell their investments at a profit, dividends, on the other hand, can be expected periodically. Many investors invest in equity-related instruments like (equity-oriented mutual funds) that are dividend-centric i.e. that provide dividend income on a regular basis.
The main aim to invest in such investment products is to gain dividend income as an alternate source of income. Investors look for investments that are high dividend-yielding investment products for this purpose. This will ensure that the investors can maximize their returns.
The dividend yield is measured using the dividend yield ratio. It is the measure of the returns that are received by the investors in terms of dividends against the market value of the shares. Stocks having a high dividend yield ratio are preferred by investors looking to earn higher dividend income through investments.
What is the formula for dividend yield ratio?
As mentioned above, the dividend yield ratio is the measure of dividends with respect to the market price of the shares. The formula for the calculation of the dividend yield ratio is mentioned below.
Dividend Yield = Dividend per share/market value per share
In the above formula, the dividend per share is the dividend that is received by the investor whereas, the market value of the share is the current price of the share in the market.
Analysis and significance of dividend yield ratio
Dividend yield ratio is relevant to investors that view dividend as an alternate source of income to meet their expenses. The dividend yield ratio is the measure of the productivity of the investment. Companies that declare dividends regularly are considered to be stable and favoured by the investors.
The dividend yield ratio can be used to evaluate between two investment options that provide the same dividends.
Let us consider the following example to understand the concept of dividend yield ratio in evaluating an investment.
| Particulars | Stock A | Stock B |
| Dividend per share | Rs. 10 | Rs. 10 |
| Market Price per share | Rs. 100 | Rs. 125 |
| Dividend Yield Ratio (Dividend per share/Market price per share) | 10% | 8% |
In the above example, both the stocks provide dividends at the rate of Rs. 10 per share but Stock A has a lower market price as compared to Stock B. The dividend yield ratio in the case of each stock is however different. Stock A although has a lower market price, the dividend yield ratio of this stock is higher. This implies that Stock A provides dividends at a higher rate as compared to Stock B. Investors who prefer investing in high dividend yielding stocks would choose Stock A for investing among the two options.
Conclusion
The dividend yield ratio is among the many ratios that are considered by the investors while making an investment decision. A correct analysis of the stock based on the dividend yield ratio cautions the investors from making incorrect investment decisions based on the market price of the stocks. It ensures that the investment objective of the investors is met by providing them sound investment options that help in generating higher dividend income.
FAQs
1. How is the dividend yield ratio used to analyze good investment options?
A. Dividend yield ratio should be used to compare investment options from the same industry or sectors to get a correct analysis of the investments.
2. Is a high dividend yield always a sign of a healthy company?
A. Declaring dividends implies sharing the company’s profits with the investors rather than reinvesting them in the company. When the company declares high dividends amid poor financial health it may be a case of misleading investors. Hence, a high dividend yield ratio cannot be the only basis for making an investment decision.
3. What is the dividend payout ratio?
A. The rate at which dividends are declared or paid out of the retained earnings are is known as the dividend payout ratio.
4. What is the meaning of record date and ex-dividend date while considering dividend yield stocks?
A. While investing in stocks having high dividend yield, investors also have to look at two other concepts namely, record date and ex-dividend date. The record date is the date declared by the company at which point all the shareholders as per the register of the company are eligible to receive the dividend to be declared. Ex-dividend date on the other hand is the date usually a day before the record date. If the investor buys the stocks on this date or after this date, they will not be eligible for receiving dividends.
Understanding these concepts will help them make better investment decisions that will eventually help them meet their investment objective.
5. What is the dividend payout ratio?
A. The dividend payout ratio is the rate at which a dividend is declared by the company. The balance profits of the company are retained by the company and can be used for various purposes like buyback of shares, reinvesting the funds in the business for expansion, or buying a new long term asset that can help in increasing the production capacity or efficiency, issue of bonus shares, etc.
