Dividend yield

Dividend yield is the annual dividend per share divided by the current share price. A company paying $2 a year with shares at $50 yields 4%. The figure describes the income return at today's price, not the return on a position bought at a different one.

A trailing yield uses the dividends paid over the last year. A forward yield annualises the most recent payment and therefore assumes it continues. The two diverge sharply around a change in policy.

The price sits in the denominator, so the yield rises whenever the price falls, whether or not anything good has happened. The table below runs one company through four events from the same starting point: $50 a share paying $2.00 a year.

The first row and the last row show the same 4% yield after opposite events. Nothing in the number distinguishes a company that has raised its dividend from one that has halved in price and then cut the payment, which is why the highest yields on any screen are weighted towards companies the market believes are in difficulty.

The price chart beside the yield usually separates them in a few seconds, and the dividend history on the company page settles it.

There is no single figure, and the useful comparison is against the sector rather than the market. Large-cap US indices have yielded low single digits in recent decades. Utilities, telecoms and real estate trusts pay substantially more because their business models and, for REITs, their tax treatment require distributing most of what they earn. Most software companies pay nothing at all, which is a statement about where they can reinvest rather than about quality.

A yield far above its sector norm is a question about the price before it is a feature of the company. The follow-up question is whether the payment is covered.

The payout ratio is the dividend measured against what the company earns. Against earnings, a company paying $2.00 a share out of $2.50 of EPS has a payout ratio of 80%. The inverse, 1.25 times, is dividend cover.

Free cash flow is the better denominator, because the dividend is paid in cash and earnings are not cash. A company can report comfortable EPS cover while paying the dividend out of borrowing, and the two measures diverge most at capital-heavy businesses where depreciation is large.

Sustainable levels differ by industry. A utility at 70% is ordinary; a cyclical manufacturer at 70% has no margin for a downturn, because the denominator falls in the year the payment matters most. Above 100%, the difference is being funded from reserves or from debt, which can continue for a period and is the pattern that precedes most cuts.

The company pages show dividends and free cash flow by year for the same decade, which is the comparison that answers this: not whether the ratio is high now, but whether the payment survived the last downturn.

Yield on cost divides the current dividend by the price originally paid rather than by the current price. Shares bought at $20 now paying $2.00 give a yield on cost of 10%, whatever the shares now trade at.

It is a record of how a holding has performed and it is not comparable with the yields on a screen, which are all quoted at current prices. The figure describes the past, and the decision to hold or sell is made against what the shares yield today.

To receive a declared dividend the shares must be held before the ex-dividend date. On that morning the price typically opens lower by approximately the amount being paid, because that cash has left the company.

Buying shortly beforehand to capture the payment therefore does not create value on its own: the holder receives the cash and holds a share worth correspondingly less, and in a taxable account an unrealised gain may have become a taxable receipt.

Four dates matter and they are frequently confused. The declaration date is when the board announces the payment. The ex-dividend date determines who receives it. The record date, usually the following business day, is when the register is fixed. The pay date, often weeks later, is when the cash arrives.

Reading a trailing yield as forward income. A trailing yield includes payments already made under a policy that may have changed, and it includes special dividends, which are one-off by definition. A single large special payment can leave a trailing yield at twice the rate the company intends to pay again.

Annualising a payment from a company that does not pay quarterly. Quarterly is common among US listers, while semi-annual and annual are usual elsewhere, so multiplying one payment by four can overstate the yield severalfold.

Screening on yield alone. The filter sorts the companies whose prices have fallen furthest to the top, which is close to the opposite of the intended search.

Ignoring withholding tax on foreign listings, which reduces the cash actually received and varies by country and by account type.