Investors investing in equity shares look for two types of returns. One is capital appreciation – increase in the market value of the shares. The second is dividend income. Companies declare dividends on equity shares from their profits. Funds left after paying off all expenses are used to create reserves and declare dividends.
The dividend is declared on the par value of the shares. For example, a 10 percent dividend on a Rs 10 par value equity share means a dividend of Re 1 per share. Even if you have paid Rs 20 to acquire the share, the dividend is payable at Rs 10. So the dividend yield would be five percent and not 10 percent.
Calculating the dividend yield is important to calculate the real returns from an investment. Also, dividend yield helps analysts in calculating the value of an investment, and whether it is worthwhile to make an investment in a particular stock.
A high dividend yield may not always indicate a good investment as it may be wiped out by losses incurred on the falling market prices of the shares. From an investment perspective, both dividend yield as well as capital appreciation are necessary to make a scrip attractive. By comparing the current yield of a scrip over a period of time, one can determine whether the growth in the dividend payout has been proportionate to the increase in the market value of the share.
The dividend yield is not equal to the amount of dividend paid by the company. It is the dividend payout with reference to the market price of the stock. It is the return on the stock by way of dividend. Dividends are always paid as a percentage of the face value of the share. When the dividend is received, it is computed as a percentage of the current market value of the share and is termed as the dividend yield.
Dividend yield also specifies how much an investor is willing to pay for the expected dividend stream generated by a single share. Investors may use the expected dividend values over a time period or the past dividend values to make the analysis.
The dividend yield indicates what percentage of the investors’ purchase price of a stock is repaid to him by way of dividends. Absolute amount of dividends do not count for this comparison. Many investors who want to have a regular income by way of dividends, look for stocks which either maintain a steady or an upward trend of dividend declaration.
They invest in scrips having a high dividend yield. Ideally, a low market price, combined with high dividend payout, would give a high dividend yield. Dividend yield is a simple tool for any investor to evaluate his investments in scrips and to build the right portfolio depending on his priorities.
Dividend yield varies for different investors for the same scrip. This is because the common denominator for calculating the dividend yield is the market price. As the cost price of each investor would be different depending on the time of his investment, the dividend yield would also be different.
For example, assume investor X purchases a scrip of company A for Rs 10. Investor Y purchases it for Rs 100 and investor Z for Rs 200. Assuming the company declares a dividend of 25 percent on the par value of Rs 10, the dividend paid is Rs 2.5 per share.
As such, the dividend yield for investor X is 25 percent, for investor Y it is 2.50 percent and for investor Z it is 1.25 percent. So, for the same amount of dividend, the dividend yield varies for different investors, depending on their cost of investment.