Let’s assume, ABC Inc is listed on National Stock Exchange (NSE) and has a stock price of Rs 100. Total number of shares issued by ABC Inc is 500. Dividend yield is defined as the ratio of dividend per share to price per share (commonly expressed as %).
Div. yield (%) = DPS / Price
where DPS is total dividend declared by the company/total number of shares
In case of ABC Inc, DPS = 2000/500 = 4. Hence dividend yield of ABC Inc = 4/100 = 4%.
When you buy shares of any company, there are two different types of returns that you can expect, capital gains and dividend income.
Suppose, you buy one share of ABC Inc today at a price of Rs 100 and sell it back after one year at a price of Rs 125. In this case, you will generate a capital return/price return of 25% (125/100-1). Suppose ABC Inc. declares a Rs.4 dividend during this period your total returns will be Rs.29 (price return + dividend return). It’s very important to understand that when you invest in shares, your total return is not just the price return, but price plus dividend return. Dividend yield is a measure of the second type of return. It is an indication how much dividend can be expected on the investment. In ABC Inc.’s case an investor can expect to get Rs 4 as dividend on an investment of Rs 100.
As discussed earlier, an early stage company might not pay dividends and might retain its profit for future investment purpose. So in this case, dividend yield will be zero. But we know that dividend is just one part of the return. Stock prices of growth companies grow fast in response to company’s higher growth rate, thereby generating substantial capital gains. One should always consider dividend yield when investing in a company’s stock, as it can be significant part of the return that might be generated. High dividend yield stocks are a good investment avenue to supplement your income needs.