Too embarrassed to ask: what is a dividend yield?

Learn what a dividend yield is and what it can tell investors about a company in MoneyWeek's latest "too embarrassed to ask” video.

Dividends – payouts made by companies to their shareholders – have been in the news a lot recently. 

Several big companies have cut or cancelled their dividends as the economic impact of the coronavirus lockdown takes its toll.  

One way to spot a company at risk of cutting its dividend is to look at the dividend yield. 

The dividend yield is simply the company’s total annual dividend per share expressed as a percentage of its current share price. 

For example, if a company paid a total annual dividend of 5p a share this year, and its share price is 100p, the dividend yield would be 5%. 

A dividend yield can be calculated based on what a company has paid out during the previous 12 months. This gives the “trailing” or “historical” dividend yield. Just remember that past dividends may not be sustainable. 

An alternative is to look at the company is expected to pay over the coming 12 months. This is the “forecast” or “forward” dividend yield. The risk here is that forecasts can be unreliable. 

A company is under no obligation to pay a dividend. It might decide not to pay out if it believes that there are better uses for the money, or that the dividend is insufficiently well-covered by profits. 

That said, management teams are often reluctant to cut, as they realise that such moves are rarely welcomed by shareholders. 

So how can the dividend yield help you to spot companies in danger of cutting?

A firm with a very high yield compared to other companies in the market or in its sector, may look cheap, and so a tempting buy. 

However, be careful. A high yield may indicate that investors expect the dividend to be cut. In other words, the yield is high because no one believes it will actually be paid.  

There are several other ways to sense-check dividend sustainability. For more on the topic, subscribe to MoneyWeek magazine.

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