Dividend yield refers to the dividend payout with reference to the market price of the stock. It is equivalent to the return on the stock by way of dividends. Dividends are always paid as a percentage of the face value of the share. When the dividend is received, it is computed as a percentage of the current market value of the share and is termed as the dividend yield.
The dividend yield also specifies how much an investor is willing to pay for the expected dividend stream generated by a single share of stock. One may use the expected dividend values over a time period or one may use the historic or past dividend values to make an analysis.
The dividend yield indicates what percentage of the investor's purchase price of a stock is repaid to him by way of dividends. Absolute amount of dividends do not count for this comparison. Many investors who want to have a regular income by way of dividends, look for stocks which either maintain a steady or an upward trend of dividend declaration. They tend to invest in scrips having a high dividend yield. Ideally, a low market price combined with high dividend payout would give high dividend yields.
Dividend yield varies for different investors for the same scrip. This is because the common denominator for calculating the dividend yield is the market price. As the cost price for each investor would be different depending on the time of his investment, the dividend yield would also be different. For example, let us say investor A purchases a scrip of company X for Rs 200, investor B purchases it for Rs 300 and investor C for Rs 500.
Assuming the company declares a dividend of 100 percent on the par value of Rs 10, the dividend paid is Rs 10 per share. As such, the dividend yield for investor A is 10 percent, for investor B it is 3.33 percent and for investor C it is two percent. So for the same amount of dividend, the dividend yield varies for different investors, depending on their cost of investment.
By comparing the current yield of a scrip over a period of time, you can determine whether the growth in the dividend payout has been proportionate to the increase in the market value of the share.
From an investment perspective, both dividend yield as well as capital appreciation are necessary to make a scrip attractive enough for investment. A high dividend yield may not always necessarily indicate a good investment as the dividend yield may be wiped out by the losses incurred on the falling market prices of the share. Dividend yield is a simple tool for any investor to evaluate his investments in scrips and to choose the right portfolio depending on his priorities.
Dividend yield is an extension of the simple logic of how much returns you get on your investments. It is not the absolute returns which are considered. It is the relative returns vis-a-vis the amount invested.