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Calculating Stock Dividend Yield

written by: Brian Nelson•edited by: Rebecca Scudder•updated: 10/2/2009

With the recent downturn in the stock market, more investors than ever are interested in dividend paying stocks, particularly high yield dividend stocks. One of the key concepts in dividend stock investing is the dividend yield.

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    What Is Stock Yield

    When it comes to investing in dividend paying stocks, it helps to understand some basic investing terms. The dividend yield is the percentage rate of return provided by the dividend to the purchaser of the stock. For these purposes, the returns provided by price appreciation in the stock are irrelevant, or looked at another way, just icing on the cake. Regardless, the yield of a dividend stock refers to the return provided by its dividend.

    A stock's yield can be calculated by taking the expected annual dividend payments of the stock and dividing by the price per share of the stock. For example, a stock trading for $50 with an annual dividend of $2.50 per share would have a dividend yield of 5%.

    High yield dividend stocks are usually considered those paying above the average stock dividend yield of the S&P 500 Index companies.

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    Using Dividend Yield as an Investment Criteria

    A stock's dividend yield can be a large factor in an investor's decision about whether or not to buy a stock. Logically, a higher yield means that the investor can expect to receive more income. However, there is a catch.

    The dividend yield of a stock is affected by two components. The first is the amount of the dividend. All other things being equal, a stock with a $5 annual dividend will have a higher yield than one with a $3 annual dividend.

    However, the other component of a stock's yield is the price at which the stock is trading. If two stocks both pay a $5 a year dividend, but one stock trades at $50 and the other trades at $25, the stock trading at $25 has a significantly higher yield. In this case, a 20% yield versus a 10% yield.

    The trap that must be avoided when purchasing a dividend stock is mistaking a high yield for a high payout. A stock whose price has dropped dramatically will have a much higher dividend even if the dividend was not increased. Indeed, it is possible for a stock's yield to increase even if the dividend is cut if the price of the stock falls far enough.

    To successfully invest in dividend stocks, the investor must distinguish between stocks whose yield is high due to a high dividend, and those whose yield is high due to a depressed stock price.

    The latter can provide a fantastic buying opportunity provided the low stock price is either a poor reflection of the company's prospects, for example, when an entire sector has had its prices driven down regardless of quality, or if the low price is an event from which the company will eventually recover.

    To provide a great investment return, a high-yielding dividend stock need not increase in value. A stock trading an all time low of $10 per share while paying a $2 dividend yields 20% per year even if the stock never increases in value. In fact, so long as the company continues to pay the same dividend, the investor can still realize a great return even if the stock price is cut in half, so long as the investor has no need to sell the stock.

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    High Yield Dividend Stocks

    The criteria for high-yield dividend stocks varies by investor, but typically includes stock whose yield is significantly higher than its peers. For many investors a yield of 4% or 5% makes a stock a high yield stock. In fact, yields higher than this are almost always indicative of a significant price drop which reflects the poor potential of the company's fortunes.