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Posted on 05 October 2012.
Individual investors often hear stock market pundits talk about dividend yield, but rarely do they explain what is dividend yield? In a nutshell the answer to what is dividend yield is that dividend yield is a financial ratio that provides a measurement regarding the amount of dividends that a company pays out each year relative to its share price. Dividend yield is yet another way to measure whether or not a particular dividend paying stock makes sense in an investor’s stock portfolio and if it is a good investment based on an investor’s investment criteria.
Here’s an example regarding what is dividend yield: a stock with a price of $50 per share that pays a $2.00 dividend on an annual basis has a dividend yield of 4.0%. By comparison, a stock trading at $25 that pays a $2.00 dividend annually has a dividend yield of 8.0%. While other factors have to be taken into consideration when investing in dividend paying stocks for income, such as how healthy the company is that is paying a dividend on their stock and how likely the dividend will continue at current levels, the dividend yield can help investors make decisions regarding whether or not various dividend paying stocks pay high enough yields to justify an investment in a particular stock.
Another way to look at what is dividend yield is to think of dividend yield as a measurement of cash payments that are received for each dollar invested in a company. The dividend yield measurement can be particularly useful for fixed income investors and other conservative investors that want to measure how much cash they are generating from their investments. Calculating dividend yield allows investors to compare income from dividend paying stocks to other forms of income investing, such as annuities and bonds.
Stocks are inherently more risky than annuities or bonds, and therefore investors considering investing in dividend paying stocks need to take this into consideration and limit their exposure to individual stocks, even if the stocks pay dividend yields that far exceed annuities or bonds. One useful way to capture high dividend yields from stocks and greatly reduce the risk associated with investing in dividend paying stocks is to buy a high dividend yield mutual fund or Exchange Traded Fund (ETF) that invests in numerous high dividend yield stocks.
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