What Is Dividend Yield?
Dividend yield is the annual dividend divided by the current share price, expressed as a percentage. Because the price is the denominator, the yield rises whenever the price falls, so a high figure often reflects a company in trouble rather than a generous one.
Dividend yield looks like a property of a company. It is a ratio between something the company decides once a year and something the market decides every second, which means most of its movement has nothing to do with the company at all.
How it works
Annual dividend divided by share price. A company paying 4 a year on a share trading at 100 yields 4%. Nothing else enters the calculation.
The numerator is set by a board once or twice a year. The denominator changes continuously. So day-to-day, essentially all of the movement in a yield is the price moving — and the yield is reported as though it were a characteristic of the business.
Which gives the mechanism that matters most here. A share halving in price doubles its yield. The company did nothing. The figure that appears on the screener went from 4% to 8% because the market decided the shares were worth less.
So a high-yield screen is mostly a list of companies whose shares have fallen. Sometimes that is an opportunity. Often it is the market pricing in the thing that happens next.
What happens next is usually a cut
The yield is quoting a payment that has already been declared. It is backward-looking by construction, and a company under enough pressure for its shares to fall heavily is a company that may reduce or stop the dividend.
When that happens the quoted yield does not fall gradually — it is simply no longer real. The figure that attracted the purchase described a payment that is not going to arrive.
And the dividend is not additional money. On the ex-dividend date the share price falls by roughly the payment, because the cash has left the company. Buying just before the date to “collect” it transfers value from one pocket to another and generates a tax event for the privilege.
The check the yield does not contain is whether the payment is affordable. That is the payout ratio: the dividend as a share of earnings. A company paying out most of what it earns has no room for a bad year, and one paying out more than it earns is funding the dividend from borrowing or reserves.
Two companies can show the identical yield with completely different safety. One covers the payment several times over from profits; the other is paying it out of the balance sheet. The yield figure is the same number in both cases, which is the clearest demonstration that it is a ratio rather than an assessment.
A worked example
Compare a yield to what cash pays. A 4% yield looks generous when deposits pay 0.5% and unremarkable when they pay 5%. Nothing about the company changed between those two worlds — the comparison did.
This is why yields move when rates move, and it is the same arithmetic covered in interest rate: every asset is a claim on future money, and the rate decides what that claim is worth.
Now the arithmetic that actually decides the outcome. A share yielding 6% whose price falls 10% in a year returned -4%. A share yielding 2% whose price rose 10% returned +12%. The higher yield produced the worse result, and a screener sorting by yield ranks them the other way round.
Over long horizons the reinvested payments do most of the work — but that is an argument for total return with dividends reinvested, not an argument for picking the highest number on a list.
The original data
Use this site’s fee measurement as the scale. Over thirty years an annual charge of 75 basis points costs 20.2% of the final balance and 150 basis points costs 36.5%.
A dividend held in a taxable account is charged at your income rate every year it is paid, which on most brackets exceeds both of those figures as an annual drag. The yield quoted on any screen is a gross number, and the one that reaches you is smaller by an amount the screen never shows.
Reinvesting also costs a round trip each time — 0.0098 on this site’s series, about 2% of the median bar range — which is small per event and repeated every quarter for decades.
When it fails
The characteristic failure is buying the top of a high-yield screen. The list is sorted, in effect, by which share prices have fallen hardest, and the yield shown is quoting a payment declared before the fall happened. The purchase is made for an income that the market has already concluded is at risk, the dividend is reduced a few months later, and the position is left holding both a lower payment and a capital loss. Nothing about the sequence was unlucky — the screen was ranking the companies in the order they were most likely to disappoint.
A second failure is treating the dividend as income and ignoring the price. They are the same pot of money, and total return is the only figure that counts both.
A third is dividend capture — buying before the ex-date and selling after — which collects a payment and an offsetting price drop, plus costs and tax.
A fourth is assuming a long payment history is a promise. A record of not cutting is evidence about the past and a company under sufficient pressure will still cut.
And a fifth is comparing yields across tax treatments. The same gross figure in a sheltered account and a taxable one are different net outcomes, and only one of those numbers is the one you spend.
Related
Interest rate covers what a yield competes against and why that moves it. Inflation covers whether the real payment is growing or shrinking. And volatility covers the price moves that do most of the work in the ratio.
The screen that sorts by highest yield is sorting, more than anything else, by which share prices have fallen furthest. That is not a list of generous companies. It took me a while to stop reading it as one, and the tell is that the yield changes every day while the dividend changes once a year.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.