Dividend Yield

Dividend Yield

The yield figure published in the newspapers is usually the historical one.

Analysts will often provide forecasts for dividends in terms of earnings per share (EPS) and thus the forecast yield can then be calculated. Forecast can, of course, go wrong, and consequently there is some risk in relying upon them.

WHY IT IS IMPORTANT

Yield, after the price/earning ration (P/E), is one of the most common methods of comparing the relative value of shares.

The majority of investors like to see a cash income from their shares, althoug to some extent this is a cultureal thing. There are more companies in the U.S., for example, that pay no dividends than in the U.K.

HOW IT WORKS IN PRACTICE

Yields can be compared against the market average or against a sector average, which in turn gives you some idea of the relative value of the share against its peers.

Other things being equal, a higher yield share is preferable to that of an identical company with a lower yield.

The higher yield share is cheaper.

In practice of course, there may well be good reasons why the market has decided that the higher yielder should be so - possibly it has worse prospects, is less profitable, and so on. This is not always the case; the market is far from being a perfectly rational place.

AN ADDITIONAL FEATURE OF YIELD (unlike many of the other share analysis ratios), is that it enables comparison with cash.

You can compare the yield from the interest rate in a bank without capital risk with the yield on shares, which are far riskier. This produce a valuable basis for share evaluation.

If, for example, you can get 4% in a bank without capital risk, you can then look at shares and ask yourself how this yield compares - given that, as well as the opportunity for long-term growth of both the share price and the dividends, there is plenty of capital risk.

TRICKS OF THE TRADE

Care is necessary, however, because unlike banks paying interest, companies are under no obligation to pay dividends at all.

Frequently, if they go through a bad patch, even the largest, most well-known household name companies will cut dividends or even abandon paying them altogether.

So, share yield is greatly less reliable than bank interst or government stock interest yield.

Despite this, yield is an immensely useful feature of share appraisal. It is the only ratio that tells you about the CASH RETURN TO THE INVESTOR, and you cannot argue with cash. EPS, for example, is subject to accountants' opinions but a dividend once paid is an unarguable fact.