Dividend yield is one of the first metrics income investors look at, but it can be misleading if not understood correctly. Put simply, it tells you how much cash flow you get back for every dollar you invest today.
The formula is simple: Annual Dividend / Current Stock Price.
For example, if a stock trades at $100 and pays $5 in dividends per year, the yield is 5%. If the stock price drops to $50, the yield jumps to 10% (assuming the dividend payment stays the same). This inverse relationship is why a "high yield" isn't always a good thingāit might mean the company is in trouble and the stock price has crashed.
Yield allows you to compare different income generating assets. You can compare the ~3.5% yield of SCHD against the 5% interest rate of a savings account. It helps you answer the question: "How hard is my money working for me?"
For retirees, yield determines cash flow. To earn $1,000 a month ($12,000 a year), you need less capital if you invest in high-yield stocks, though this often comes with higher risk.
Remember, yield is based on the past or current payout. Dividends are not guaranteed. A company can cut its dividend at any time. Also, chasing the highest yield often leads to "yield traps"ācompanies with unsustainable payouts that eventually cut dividends, causing stock prices to fall further.
Ready to see the math in action? Use our calculator to see how much capital you need based on different yield scenarios.
DISCLAIMER: This article is for educational purposes only and does not constitute financial advice. Dividend yields change daily based on market price.