Dividend Yield Explained

Dividend yield is a financial ratio that measures how much a company pays shareholders in dividends relative to the stock price. It answers the question: "If I buy this stock at today's price, what percentage will I earn annually in dividends?"

Yield is expressed as a percentage and is calculated annually, even if dividends are paid monthly or quarterly.

Example: If a stock trades at ₹2,000 per share and pays ₹100 in annual dividends per share:

This means if you buy at ₹2,000, you'll earn ₹100 annually, or 5% on your investment.

Low Yield (0-2%): Typical of growth companies and tech stocks. They reinvest profits for expansion rather than paying dividends. Examples might include younger companies or high-growth sectors.

Medium Yield (3-6%): Common for mature, stable companies. Banks, utilities, and established consumer brands typically pay 4-5% yields. This is considered "healthy" yield territory.

High Yield (7%+): Might sound attractive but requires caution. High yields can signal either:

• Strong, stable business with excellent shareholder returns (rare)
• Stock price decline that pushed yield up (warning sign)
• Unsustainable dividend that may be cut soon

A yield trap is when a seemingly attractive high dividend yield masks underlying problems with the company or stock.

How it happens: A company's stock price falls from ₹1,000 to ₹400 due to declining business. If the dividend remains ₹50/year, the yield jumps from 5% to 12.5%—very appealing! But this might be a trap if:

• Earnings are declining (dividend may be cut next)
• Payout ratio exceeds 100% (paying more than they earn)
• Debt is increasing and margins are shrinking
• Business fundamentals are deteriorating

How to avoid yield traps: Always check the payout ratio, growth trends, and competitive position before buying a high-yield stock.

Yield on Cost is a crucial metric that many investors overlook. While regular dividend yield is based on the current market price, Yield on Cost is based on the price you paid.

Example: You buy a stock at ₹1,000 per share with a 5% yield. You invest ₹1,00,000 and earn ₹5,000 annually. After 5 years, the dividend grows to ₹6,000/year, but the current market price is now ₹1,500.

• Current Dividend Yield = (6000 / 1500) × 100 = 4%
• Your Yield on Cost = (6000 / 1000) × 100 = 6%

Your YoC shows your actual return on the money you invested, not what a new investor would get today. This is why long-term dividend investors can enjoy yields that increase over time even if current market yields fall.

A stock's yield changes constantly because it depends on the current stock price. If a company pays a fixed ₹50 annual dividend:

• At ₹1,000 stock price: 5% yield
• At ₹1,250 stock price: 4% yield
• At ₹833 stock price: 6% yield

Stock prices bounce around based on market sentiment, earnings announcements, and economic conditions. Meanwhile, dividends (if funded by stable earnings) tend to grow modestly over time.

This is why dividend investing shines during market downturns: stock prices fall (making yields rise), and if earnings remain stable, you can deploy capital at higher yields.

Beyond the current yield, savvy investors track dividend growth rate—how fast the annual dividend is increasing.

A stock with 3% current yield but 10% annual dividend growth might be more attractive long-term than 6% yield with 0% growth. Use our DRIP calculator to see how dividend growth compounds your wealth.

When evaluating dividend stocks, consider not just yield but:

• Payout Ratio: Is the dividend sustainable? Look for ratios below 60%
• Dividend History: Have dividends grown consistently?
• Earnings Growth: Can the company maintain/grow earnings?
• Industry Strength: Is the business competitive?
• Debt Levels: Is the company over-leveraged?

You find two dividend stocks, both yielding 5%:

Both offer 5% yield, but Stock B is likely the better choice. Lower payout ratio means sustainable dividends. Faster growth means your yield on cost will expand over time. Stable earnings mean dividends are unlikely to be cut.

• Dividend yield = Annual Dividend per Share / Current Stock Price
• Healthy yields are typically 3-6%; above 8% warrants investigation
• High yields can be traps if the company fundamentals are deteriorating
• Yield on Cost shows your actual return based on what you paid
• Long-term dividend investors benefit from compounding and growing yields