Ratios: Dividend Yield Ratio - Online Tutor, Practice Problems & Exam Prep

The dividend yield ratio measures the cash dividends received per dollar invested in a stock, expressed as a percentage of the market price. It is calculated using the formula: $\frac{D}{P}$, where D is dividends per share and P is market price per share. A high yield indicates stable income, while a low yield may suggest reinvestment for growth. Investors use this ratio to assess investment potential, balancing between cash returns and capital appreciation.

Ratios: Dividend Yield Ratio

Let's check out a ratio here, the dividend yield ratio. All right. So the dividend yield ratio, it's going to show how much dividends we yield when we own a share of stock. Right? It's a percentage of the market stock price distributed as dividends. Okay? So the dividend yield ratio, this is a market value ratio. These market value ratios, well, they're going to use the market value of the stock. Right? Any stock, we can look it up on the market that's by a public company, Apple stock, Microsoft, whatever it is. You look it up on the stock exchange and it's got a market price. Alright? So this market price is going to have to be given to you in the questions and you're going to use it to solve for the dividend yield ratio. Alright? So the ratio is, as we see here, notice in the numerator, we've got the dividends per share. So remember, it's per share of common stock. The dividends per share that they receive divided by the market price per share. So it's going to say something like, you know, the market price of the stock is $20. Something like that in the question. So we usually show this as a percentage, and that's why we multiply by 100 here. So we show this as a percentage. So what does the dividend yield ratio tell us? Remember, this is a ratio that's used by investors to see whether or not this is a good investment or not or it fits their portfolio. So what it tells us, it's the amount of cash dividends that they receive per dollar invested. Okay? Per dollar invested in this stock. So how much dividends are you getting per dollar? And that's a good number when you think about it. You can compare across different companies when you look at different dividend yield ratios. Well, that's how much percentage you're going to get back as cash when you invest in this stock. So remember, there are going to be 2 ways that we make money when we invest in stocks. The first one is through dividend payments. Right? Because these are actual cash returns. You own a piece of stock and you're getting some money. So that is a return on your investment. Let me get out of the way here so you can see the rest of this. But there's another way that we make money too, right? The investors in the stock, they also get a return through capital appreciation. Okay, and this means that say you paid $20 for a share of the stock and now the stock is worth $25 well, when you sell it, you're getting that $5 appreciation, right? From 20 to 25, you get money that way as well. So, those are the 2 ways we make money and we think, when we think about a dividend yield ratio, well, we might see a low dividend yield ratio or a high dividend yield ratio. Well, either way, it can be seen as a good thing or a bad thing. Companies that don't pay dividends or pay small dividends, it's not necessarily a bad investment. Small dividends tend to mean that that company is reinvesting their earnings, right? Since they're not paying dividends while they're taking the money that they earned during the period and reinvesting it into the business, right? So when they reinvest into the business, well, that means that they're going to be growing, right? And we would expect to see capital appreciation. We'd see the stock price going up. The other side of it is high dividends. When we see high dividends, well, this is seen as stable realized income, right? Because you're actually getting cash back from your investment. So when you have a high dividend yield ratio, this is this feels more like a stable investment that you're actually getting cash returns from. Where the small dividend ratio, well, you're seeing this as a growth opportunity. Right? So in the end, this is a pretty easy ratio to calculate. We just have to calculate our dividend per share. Sometimes they might give you the total dividends paid to all the investors and then a number of shares. Well, you'll have to get the dividend per share by dividing the two. And then the market price per share, they will usually just tell you $20, $50 whatever it is, okay? So let's go ahead and jump into some practice and you guys try and calculate the dividend yield ratio, alright? Let's do it now.

During the current year, PayCo declared and paid a cash dividend of $600,000. The number of shares of common stock outstanding is 1,000,000. If the current market price of the stock is $15, what is the dividend yield ratio?

• A. 2%
• B. 4%
• C. 8%
• D. 12%

ABC Company's common stock currently has a market price of $20, while total stockholders' equity has a book value of $600,000 (60,000 shares outstanding). During the current year, ABC Company maintained a dividend yield ratio of 8%. What was the total amount of dividends paid to common stockholders?

• A. $24,000
• B. $48,000
• C. $72,000
• D. $96,000

Here’s what students ask on this topic:

What is the dividend yield ratio and how is it calculated?

The dividend yield ratio measures the cash dividends received per dollar invested in a stock, expressed as a percentage of the market price. It is calculated using the formula:

$\frac{D}{P}\times \; 100$

where $D$ is dividends per share and $P$ is market price per share. For example, if a stock has a market price of $20 and pays dividends of $1 per share, the dividend yield ratio would be:

$\frac{1}{20}\times \; 100\; =\; 5\%$

Why is the dividend yield ratio important for investors?

The dividend yield ratio is important for investors because it helps them assess the potential return on their investment in terms of cash dividends. A high dividend yield indicates a stable income, as it shows that the investor is receiving a significant amount of cash dividends relative to the stock's market price. Conversely, a low dividend yield may suggest that the company is reinvesting its earnings for growth, which could lead to capital appreciation. By comparing dividend yield ratios across different companies, investors can make informed decisions about which stocks align with their investment goals, whether they seek immediate income or long-term growth.

How do you interpret a high dividend yield ratio versus a low dividend yield ratio?

A high dividend yield ratio indicates that a company is paying a substantial amount of its earnings as dividends, providing stable and immediate cash returns to investors. This is often seen as a sign of a mature, stable company. On the other hand, a low dividend yield ratio suggests that the company is reinvesting its earnings back into the business to fuel growth. While this means less immediate cash return, it could lead to capital appreciation as the company's value increases over time. Investors must balance their need for current income with their desire for future growth when interpreting these ratios.

What factors can affect the dividend yield ratio of a company?

Several factors can affect a company's dividend yield ratio. Firstly, the company's dividend policy plays a crucial role; companies that prioritize returning cash to shareholders will have higher dividend yields. Secondly, the market price of the stock impacts the ratio; if the stock price increases without a corresponding increase in dividends, the yield will decrease. Thirdly, the company's earnings and profitability influence its ability to pay dividends. Lastly, broader economic conditions and investor sentiment can affect both stock prices and dividend policies, thereby impacting the dividend yield ratio.

Can a high dividend yield ratio be a sign of a risky investment?

Yes, a high dividend yield ratio can sometimes be a sign of a risky investment. While it indicates that the company is paying substantial dividends, it could also suggest that the stock price has fallen significantly, possibly due to underlying financial issues. Investors should investigate the reasons behind a high dividend yield to ensure it is not a result of declining stock prices or unsustainable dividend payments. It's essential to consider other financial metrics and the overall health of the company before making investment decisions based solely on the dividend yield ratio.