Financial Statement Analysis - Dividend Yield

The dividend yield is used to calculate the earning on investment (shares) considering only the returns in the form of total dividends declared by an organization during the year. By dividing the stock's annual dividend by the stock's price and multiplying by a hundred, you get a percentage.

You can think of that percentage as the interest on your money, with the additional chance at growth through the appreciation of the stock.

Calculating dividend yield

For example: If an organization has:

• A stock with a value of $5
• And it pays an annual dividend of $0.50

Then it has a dividend yield of 0.5 ÷ 5 = 0.1
Expressed as a percentage, this is 10%.

Dividends are declared and paid quarterly and a dividend increase is announced in advance. This makes the stock more valuable or desirable to equity income investors, who start buying the stock in anticipation of the higher dividend. This in turn pushes the stock price up, so that when the higher dividend is actually paid, the stock price is likely to be higher and the dividend yield will remain the same.

If a good dividend stock drops in price, the increased dividend yield will attract equity income and value investors, whose stepped-up purchases will push the stock price back up and the dividend yield down. If, however, a higher dividend yield fails to attract investors, it may be an indication of financial problems that are too serious to be offset by a higher dividend.

Where an organization has a low dividend yield compared to others in its sector, it can mean one of two things:

1. The share price is high because the market believes that the organization has exciting prospects and that the future increase in share price will more than compensate for a lack of dividend payments.

2. The organization is in trouble and cannot afford to pay reasonable dividends.
At the same time, however, a high dividend yield can signal a 'sick' organization with a depressed share price.

Dividend yield fell out of favor during the 1990s because of an increasing emphasis on price appreciation over dividends as the main form of return on investments. Dividends also vary by industry, with utilities and some banks paying a lot, whereas technological firms invest almost all their earnings back into the organization to fuel growth and protect their technological advantage.

The more you know about how an organization is performing financially, the easier it will be for you to make informed management decisions about it. key accounting ratios can help you to find out:

• Is an organization solvent?
• Is it profitable?
• How well is it managed?

Making a simple financial assessment of another organization is straightforward and the necessary information is readily available. This means that you can compare the performance of the organization with its previous track record and with the performance of other similar organizations. You can also make comparisons to see how profitable the business is, how efficiently it is performing, and whether it is able to pay its bills on time.

This Key Financial Ratios Checklist details the key financial ratios you can use to help you interpret financial information. This Financial Ratio Formulas Checklist provides you with a list of the most popular financial ratios used to assess an organization's performance, solvency, profitability and investment potential.

If you need a basic financial accounting principles pdf then download our free eBook now.

This ability to evaluate the financial position of another organization is a valuable skill for any manager to have, whether you are choosing a supplier, considering a strategic partnership, or deciding how much credit to extend to a customer.

Remember, the ability to communicate in the language of finance becomes more of an asset the higher you progress up through the levels of management, even if accounting and finance is not your specialty.

You may also be interested in:
Financial Statement Analysis | Key Accounting Ratios | Types of Key Accounting Ratios | Current Ratio Analysis | Calculating Profit | Business Performance Ratios | Price/Earnings Ratios | Price-to-Book Ratio | PEG (Price/Earnings to Growth) Ratio.

Key Points

  • The dividend yield is used to calculate the earnings on investment (shares) considering only the returns in the form of total dividends declared by an organization during the year.
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