A dividend yield is simply a company’s total annual dividend per share – the amount of money it has paid or will pay to shareholders in a year – divided by its current share price and expressed as a percentage. For example, if a company paid a single dividend of 10p per share this year and its shares are trading at a price of 1,000p, the dividend yield would be 10p ÷ 1,000p = 0.01 (which is 1%). If the firm paid a dividend of 5p after half a year (usually called an interim dividend) and a further 10p at the end of the financial year (a final dividend), you would add the two together and get (5p + 10p) ÷ 1,000p = 0.015 (1.5%).
Dividends are not fixed: a company may vary its dividend according to how profitable the past year has been, whether it needs to hold on to more of its profits to invest in maintaining or growing its business, or whether it has more cash than it needs and wants to make an extra one-off payment to shareholders (often called a special dividend). So we need to take this into account.
To get a more complete picture, the dividend yield can be calculated based on what the firm paid in the past 12 months or calendar year (sometimes referred to as the trailing or historical dividend yield) or on the amount that it’s expected to pay over the next 12 months (a forecast or forward dividend yield). Trailing yields reflect what has actually been paid – but past dividends may not be sustainable. Forecast yields reflect any changes that analysts expect – but forecasts are unreliable.
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Investors should look at both, but should not rely solely on either to make their decision: you need to think about the long-term prospects for a firm’s dividends, including any signals that the market is sending. A firm with a very high yield may look cheap, but this could indicate that investors expect the dividend to be cut. Meanwhile, a firm with a lower yield might be expected to grow it rapidly in the years ahead.
See Tim Bennett's video tutorial: How to pick income winners: What is a dividend yield?
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