Dividend yield is the dividend per share divided by the share price. Dividend yield is an important ratio in selecting stocks. High dividend yield stocks are more attractive, valuation wise, compared to low dividend yield stocks. Dividend yield, as such, is an important ratio for value investors. High dividend yield stocks give higher returns in volatile and down markets; even if share prices are down, investors get cash-flows in form of high dividends.
However, investors should understand that high dividend yield stocks will not necessarily give better returns than low dividend yield stocks. Dividends are paid from the profit after tax (or earnings per share) of a company. Profit after the tax can either be paid out as dividends to shareholders or re-invested back in the company or combination of both, at the discretion of the management of the company. If the management thinks that there are opportunities to invest in the business for higher revenue and earnings growth then it will reinvest a greater share of the profit after tax in the business and consequently have a lower dividend payout rate (lower dividend yield). Higher earnings growth in the future, will lead to higher share price appreciation and future returns for shareholders. Some companies on the other hand, may want to distribute a bigger share of the profits to shareholders and consequently have higher dividend yields. High dividend yield stocks are value stocks and tend to be more stable / less volatile than low dividend yield stocks. Investors should make informed decisions based on their risk appetite and investment goals.
