The formula for a share’s dividend yield is fairly straightforward:
Dividends per share divided by share price.
There are two types of yield you need to know about, however.
The first is the trailing yield, which is based on the dividends per share the company paid over the last twelve months.
For instance, if the company paid 10p per share in dividends over the past year and the share price is 250p, the trailing yield is 4% (10p / 250p).
In other words, if you bought 400 shares today at 250p (£1,000 worth) and the dividend per share was held flat at 10p over the next year, you would expect to generate £40 (400 x 10p) in dividends over the next year.
The second type of yield is the forward yield, which is the estimated dividend per share over the next twelve months divided by the current share price.
Sticking with the previous example, if you expect the company to pay 15p over the next twelve months and the share is trading for 250p, the forward yield is 6% (15p / 250p) and you would expect to receive £60 (400 x 15p) in dividends over the next year.
Pros and cons of forward yield
The problem with the forward yield is that we normally don’t know exactly how much the next year’s dividend will be.
If the company is expected to raise its dividend over the next year, the forward yield will be higher than the trailing yield.
Bear in mind, however, that the actual dividend per share could be lower than had been expected, so be careful not to rely too much on forward yields unless you think the estimated dividend is achievable.
Finally, it’s important to know that a share’s yield and share price have an inverse relationship – when one goes down, the other goes up.
Only a short article this week, but as dividend yield will be so fundamental to our discussions going forward, I think it warrants a standalone explanation.
Next time we’ll look more closely at corporate dividend policy, and how it can help you make better dividend share choices.
Until then, please do share your feedback and thoughts below.
See all of The Analyst’s articles on dividend investing.