Holders of ordinary shares in a company are paid a percentage of that company’s profits every year. The payment is called a dividend. The percentage is not worked out using an exact formula, but decided by the board and approved by shareholders at the AGM, depending on the company’s performance and priorities.
The dividend per share (total dividends paid out divided by total number of shares) expressed as a percentage is referred to as the dividend yield. So if a share is trading at 100p, and the dividend paid out last year was 2p, the yield is 2%.
This is a popular measure for comparing stocks, but note that it is retrospective – telling you what the company paid out last year, not what it might pay out next. A low yield often – but not always – suggests a fast-growing company not yet making much profit.
Investors will accept a low yield now in exchange for an anticipated high yield in the future. A high yield often indicates either a very risky or slow-growing company; investors demand a higher yield as compensation to invest in either.
• See Tim Bennett’s video tutorial: How to pick income winners: What is a dividend yield?