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%. It tells you the income return at today's price, which is not the same as the income return you would get if you bought at a different one.

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

The yield is a fraction, and the price is in the denominator. When a share price halves and the dividend has not yet been cut, the yield doubles - so the highest yields on any screen are disproportionately companies the market believes are in trouble.

This is the single most important thing to understand about screening for income. A yield that has risen because the payment increased is a different event from one that has risen because the price collapsed, and the number itself cannot distinguish them. Looking at the price chart beside the yield usually can.

The payout ratio - dividends as a share of earnings, or better, of free cash flow - is the usual test of sustainability. A company paying out more than it earns is funding the dividend from its balance sheet or from borrowing, which can continue for a while but not indefinitely.

Different industries sustain very different ratios. Utilities and real estate trusts pay out most of what they make by design; a cyclical manufacturer at the same level is in a far more precarious position. As with the P/E, comparison across sectors is where this ratio misleads most.

To receive a declared dividend you must own the shares before the ex-dividend date. On that morning the price typically opens lower by roughly the amount being paid, because the value of that cash has left the company.

So buying shortly before an ex-dividend date to capture the payment does not create value on its own: in the simplest case you receive the cash and hold a share worth correspondingly less, and in a taxable account you may have converted an unrealised gain into a taxable receipt for no gain at all.