5 min read
- What is the Dividend Yield Ratio?
- Formula - Dividend Yield Ratio
- Real World Example of Dividend Yield Ratio - NMDC Ltd.
- Advantages and Disadvantages of Dividend Yield
- Factors Affecting Dividend Yield
- Taxation on Dividend Income
- Some High Dividend Yield Stocks
- How to Use Dividend Yield in Your Investment Strategy
- Conclusion
- FAQs
The Dividend yield is a financial ratio that represents the percentage of a company’s dividend relative to its current share price. The dividend yield will change as the share price fluctuates. Here, we will provide a clear explanation of dividend yield, including its definition, formula, calculation method, advantages, disadvantages, and how dividend income is taxed. Let’s dive in and explore everything you need to know about dividend yield.
What is the Dividend Yield Ratio?
A dividend is a portion of a company’s earnings distributed to its shareholders as a reward for their investment. There are 2 main forms of dividends:
- Cash dividend: Cash payment is made directly into the bank accounts of the shareholders. This is the most common form of dividend, providing immediate cash income to investors.
- Stock dividend: A stock dividend is a type of dividend where shareholders receive extra shares of stock rather than a cash payout. This increases their total number of shares but not necessarily their total investment value.
Dividend yield applies to cash dividends and shows what percentage of the stock price you will receive as a dividends in a financial year. In other words, it indicates the percentage of return you will get from dividends on your investment value.
As the stock price fluctuates—going up or down—the percentage of dividend yield also changes.
Example: XYZ Ltd.
Current stock price: INR 100
Annual dividend Payment per stock: INR 4
So, Dividend yield = 4%
But, if the stock price changes to INR 120
Annual dividend payment per share remains the same (4)
Then, the Dividend Yield will become 3.33%
Paying dividends is not compulsory; it is up to a company’s management to decide whether to distribute them. A company not paying dividends does not necessarily mean it is not generating profits. It could be the reason, but other factors might include reinvesting profits into business growth or expansion, repaying debt, or retaining earnings to prepare for uncertain future economic conditions.
Formula - Dividend Yield Ratio
The formula for the dividend yield ratio is:
Dividend yield = Annual Dividend Per Share / Price Per Share * 100
Where,
Annual dividend per share: It is the total amount of dividend a company pays to its shareholders, in a financial year.
Price per share: It refers to the current price of the company’s shares.
Real World Example of Dividend Yield Ratio - NMDC Ltd.
NMDC Steel Ltd.
Current stock price: INR 222
Dividends payments:
27 February, 2024 – INR 5.75
31 August, 2023 – INR 2.85
Note: NMDC Steel has not paid any dividends so far in the financial year 2024-2025. Therefore, to estimate the dividend yield for this year, we consider the dividend payments from the financial year 2023-2024, assuming the company will pay the same amount of dividend in the current year. This forecasting assumption is commonly made by analysts and investors to provide an estimate, but it is not guaranteed and should be adjusted as new information becomes available.
Dividend yield = Annual Dividend Per Share / Price Per Share * 100
5.75 + 2.85 / 222 * 100 = 3.87%
The Dividend yield for NMDC Steel is 3.87%
Advantages and Disadvantages of Dividend Yield
Advantages
- Comparisons: Dividend yield helps investors compare the income potential of different stocks, making it easier to identify high-yield investment opportunities.
- Sigh of financial health: A steady or high dividend yield can indicate a company’s strong financial stability and profitability. It often suggests that the company is stable and able to generate enough earnings to distribute regular dividends to shareholders.
- Total returns: In addition to stock appreciation, dividend yield contributes to the total return on investment, enhancing overall returns.
Disadvantages
- Fluctuations in share price: The dividend yield can fluctuate based on changes in the stock price. When the stock price rises or falls significantly, the yield can appear higher or lower, which may not accurately reflect the true return on investment. These variations can make the dividend yield less reliable as a measure of how much income you’re actually earning from your investment.
- Dividend cuts: Companies might lower or stop paying dividends if they run into financial trouble. If a company is struggling, it might cut or eliminate its dividend payments. Therefore, just looking at past dividend yields might not be a reliable way to predict how much the company will pay in the future.
- Not a complete measure: While dividend yield shows how much a company pays out in dividends relative to its stock price, it doesn’t reflect other important aspects of the company’s health. Therefore, relying solely on dividend yield might give an incomplete picture.
Factors Affecting Dividend Yield
- Company’s dividend policy: Companies have different policies regarding dividends. Some might pay high dividends regularly, while others may pay lower or irregular dividends based on their earnings and business needs.
- Stock price fluctuations: Dividend yield is directly influenced by changes in the stock price. Because the yield is calculated by dividing the annual dividend payment by the current stock price, a rising stock price can lower the yield, making it seem less attractive. Conversely, if the stock price falls, the yield can increase, potentially giving a misleading impression of high returns.
- Economic conditions: Economic conditions can impact dividend yields. During economic downturns, companies might cut or eliminate dividend payments to preserve cash.
- Company’s earnings: A company’s earnings are crucial for its dividend yield because they determine whether the company can keep paying or increase its dividends. If the company’s earnings go up, it might boost its dividend payments. If earnings go down, the company might reduce or stop its dividends.
Taxation on Dividend Income
In India, dividends received on stocks are subject to taxation under the following rules:
- Tax Deducted at Source: According to Section 194 of The Income Tax Act, 1961 companies paying dividends are required to deduct TDS at a rate of 10% if the total dividends exceed ₹5,000 within a financial year.
Note: If your dividend payment exceeds 5000 in a financial year from a single company, then only TDS will be deducted. Eg: If you are earning INR 3000 from 10 companies in a financial year which is equal to 30,000, no TDS will be deducted as you are earning dividends from 10 different companies.
- TDS for Non-Resident Individuals (NRIs): TDS for Non-Resident Individuals (NRIs): As per Section 195 of the Income Tax Act, 1961, a 20% TDS will be deducted from dividend income earned by NRI investors on equity shares or equity mutual funds.
- Deduction on Interest Expense: According to The Finance Act, 2020 investors can claim for deduction on interest expenses against the dividend income, and the deduction is allowed only 20% of the total dividend income received.
- The Finance Act, 2020: It states that dividend income will now be taxed in the hands of the investors, at the applicable income tax slab rate.
Some High Dividend Yield Stocks
Here is a list of high dividend-paying stocks as of August 2024.
| Stocks | Dividend Yield |
|---|---|
|
Bharat Petroleum Corp. (BPCL) |
5.88% |
|
Indian Oil Corp. (IOCL) |
6.76% |
|
Coal India |
4.73% |
|
Vedanta Ltd. |
6.25% |
|
Hindustan Petroleum Corp. (HPCL) |
5.18% |
|
Balmer Lawrie Investments |
4.05% |
|
Chennai Petroleum Corporation |
5.41% |
|
Jagran Prakashan |
5.27% |
|
Allsec Technologies |
4.16% |
|
Oriental Carbon & Chemicals |
5.03% |
How to Use Dividend Yield in Your Investment Strategy
- Income Investing: If your main goal is to generate regular income, focus on companies with high and sustainable dividend yields. Diversify your investments across various high-yield stocks to help ensure a steady income stream.
- Growth Investing: If you’re more interested in capital growth, you might prefer companies with lower dividend yields but higher growth potential. Companies that reinvest their earnings into the business often offer significant capital appreciation for shareholders. To assess a company’s growth potential, consider performing a fundamental analysis.
- Balanced Approach: Many investors adopt a balanced approach by combining dividend-paying stocks with high-growth potential stocks in their portfolios. This strategy offers a blend of steady income from dividends and the opportunity for significant capital appreciation.
Conclusion
The dividend yield is an essential measure for investors. By understanding what it means and how it is calculated, you can make more informed decisions. However, it’s important not to rely solely on dividend yield when making investment choices. Be sure to also consider factors such as the company’s financial health, market conditions, competitive analysis, cash flow, other financial ratios, etc.
FAQs
Q1. Is paying dividends mandatory for a company?
A1. No, it is not compulsory for a company to pay dividends. A company can choose to distribute dividends to shareholders, but it may also decide to use its earnings for reinvestment, paying down debt, building reserves, etc.
Q2. If a company’s share price increases, will the company pay more in dividends based on the dividend yield?
A2. No, the company’s dividend payments are not automatically increased if the share price goes up. Dividend payments are decided by the company’s board and are based on various factors such as profits, financial health, and strategic goals. If the share price increases while the dividend amount remains unchanged, the dividend yield will decrease.
Q3. If a company is not paying dividends to its investors, is it considered a negative sign?
A3. A company not paying dividends to its shareholders is a negative sign only if the company is making losses or not generating earnings. If the company is not paying dividends for reasons such as reinvesting in growth and expansion, repaying debt, or building reserves, it is generally not a negative sign.
Q4. What factors can influence a company’s dividend yield?
A4. A company’s dividend yield can be affected by changes in its stock price, its dividend policy, overall economic conditions, and the company’s earnings. Changes in the stock price can affect the yield, whereas variations in earnings or economic conditions can influence the company’s ability to distribute dividends.
Also Read
