What is Dividend Yield – Meaning, Calculation & Taxation

Meaning – Dividend yield is a key financial ratio that shows the dividends companies pay to investors relative to the market value of their shares.  In other words, dividend yield represents the relationship between the dividend paid by a company and its share prices. It is an essential metric for investors because it helps them analyse their potential income on the invested capital. To understand dividend yield better, let us first get to know the concept of dividends:

What Are Dividends?

Dividends refer to that portion of company profits distributed amongst the shareholders, usually in the form of cash. These dividends are mostly paid on a quarterly basis; however, some organisations prefer them to be paid on a semi-annual or annual basis. The frequency and amount of dividends to be paid depend on the discretion of the company’s management and shareholders’ votes. 

In most cases, large or matured companies offer dividends to their shareholders on a more consistent basis because they have a considerable profit surplus and better cash flows. Such companies usually fall under the large cap category and tend to reward their investors through dividend payouts in return for their capital. 

On the contrary, companies in their growth or initial stages of operation prefer to retain their profits for reinvestment purposes for future expansion and growth. Another reason for not paying dividends by these companies is their inconsistent profit growth.

• Dividends are a form of income distributed among investors as a portion of a company’s earnings.
• Dividends are paid out of the surplus profit of a company after deducting all the necessary expenses.
• Dividend distribution is a voluntary duty, and the decision to pay dividends is at the discretion of the company’s Board of Directors (BOD) and shareholders.

Types Of Dividends

Every listed company that offers dividends to its investors pays them in different forms and at various frequencies. For ease of understanding, let us get a hang of the distinct types of dividend payments:

1. Final Dividend – The final dividend is the annual dividend that a company pays to the investors after the assessment of the financial health of a company. It is paid after the consent of the shareholders at the Annual General Meeting (AGM) of a company at the end of a financial year. After analysing the company’s financial statements and profitability, the board of directors proposes the final dividend amount. Once the shareholders agree to the same, the dividend is declared and paid on a specific date. 

2. Interim Dividend – Interim dividend is the dividend paid by a company during the middle of a year or before preparing the annual financial statements. The interim dividend value is generally lower than the final dividend because it is based on a company’s mid-year profitability and performance. 

3. Preferred Dividend –  As the name suggests, preferred dividends are paid to shareholders who hold the company’s preferred shares. The amount of dividend paid to preferred shareholders is usually fixed and paid before any dividend payments on common stock. 

4. Special Dividend – Special dividends are paid to investors as extra dividends, which is different from the standard dividend payments. It is usually distributed in the form of cash, reflecting the accumulation of substantial earnings or windfall gains by a company due to a corporate event.

What Is Dividend Yield?

The dividend yield is the mathematical representation of the relationship between the annual dividend paid and a company’s share price. The yield value is the percentage of the share price that a company pays in the form of dividends. Since it is just a ratio, the absolute value of dividends you receive on your investment will be different from the yield. The dividend yield is mostly a comparative and analysis tool that assists investors in the decision-making process.

The dividend yield value is highly susceptible to change as per the variation in stock prices. While calculating yield, stock prices are used as denominators, which means if we assume that the dividend paid is kept constant and the stock prices increase, then the yield value decreases, whereas when the stock prices decline, the yield value rises. Therefore, while analysing a company based on its yield value, investors must be cautious about the increase and decrease in the market prices of its relative stocks. 

Example: Suppose there is a listed company, XYZ, that has its shares trading on the stock market at Rs 250 per share. The company management has decided to offer an annual dividend of Rs 5 per share. Now, you want to calculate the dividend yield of the company. To do so, you can perform the following calculations:

Dividend yield of the company XYZ = (annual dividend per share/market value per share)*100

          = (Rs 5 / Rs 250)*100

          Dividend yield = 2%

• The dividend yield measures the dividend paid as a percentage of the market value per share.
• Yield is a key ratio used for performing peer-to-peer comparisons of companies based on their ability to pay dividends.

How Is Dividend Yield Calculated?

To calculate the value of dividend yield, the below formula can be used:

Dividend Yield = Annual dividend per share/ market value of a share

Here, the dividend per share refers to the annual dividend paid by a company per share, and the market value of a share refers to the current market price of the company’s share. 

However, each listed company offers dividends at different frequencies, so one should consider the dividend payment frequency when calculating the yield value. For example, most companies in India pay dividends quarterly or annually; hence, investors must calculate the annual dividend value before using the quarterly dividends to derive the dividend yield, or if the dividend is paid annually, the annual dividend amount is used.

What Can You Conclude From The Dividend Yield Value?

The conclusion derived from the dividend yield varies from investor to investor and industry to industry. However, one common interpretation that can be derived from dividend yield is how much cash flow an investment can generate over a particular period. This helps investors to compare different companies based on the expected cash flow they can offer and make a wise investment decision. 

However, a decision based solely on a company’s dividend yield can be a wrong approach. This is because increasing yield does not necessarily mean that the dividend paid per share is growing; it may indicate that the share price is falling considerably, which can plunge the invested capital.

Example: Consider the following 2-year data of a listed company A.

The dividend yield for year 1 = (Rs 10 / Rs 200)*100 = 5%

The dividend yield for year 2 = (Rs 10/ Rs 100)*100 = 10%

As can be seen from the above example, when the annual dividend per share is kept the same for both years, and the CMP per share is decreased in year 2, the dividend yield subsequently increases. We can conclude that an increase in the dividend yield does not necessarily mean that the dividend has also increased.

• Dividend yield informs investors about the expected cash flow on their investments in a listed company.
• Dividend yield can fluctuate based on stock prices; therefore, investors should be careful when analysing it.

Dividend Yield VS Dividend Payout Ratio

As mentioned above, the dividend yield is simply the rate of return on your investment relative to the company’s stock prices. It is not an absolute value but a ratio that makes comparisons easy among companies. However, the dividend yield can sometimes be misleading due to drastic changes in stock prices. 

Therefore, many investors also look at the dividend payout ratio to assess the ability of a listed company to provide dividends over the investment durations. The dividend payout ratio differs from the dividend yield because it represents the percentage of net earnings distributed among the investors as dividends. Dividend payout ratios provide a more clear picture of dividend payments that investors can expect to earn over a period. 

Key Differences between dividend yield and dividend payout ratio

Dividend yield 

1. It represents the relationship between the annual dividend amount and the market value of a share.
2. Formula = Annual dividend per share/ market value of a share

Dividend payout ratio 

1. It represents the relationship between the annual dividend and net earnings per share.
2. Formula = Annual Dividend per share/ net earnings per share

Factors Affecting Dividend Yield

1. General Economic Condition – Generally, when there is a positive momentum in the economy, companies perform better and offer good dividends to their investors. However, the opposite may also happen during economic downturns when the cost rises, and companies try to reserve their profits and cash rather than distributing them in the form of dividends.

2. Financial Performance – A company’s financial performance is the core analysis tool, which should be analysed thoroughly before making an investment decision. Companies with a positive cash flow and sound profitability can often pay better dividends. In contrast, organisations with inconsistent cashflows and weak profitability are not able to offer good or consistent dividends to investors. 

3. Operational Stage – Each company operates at different levels of growth and operations, which can affect its ability to offer dividends and thus influence the dividend yield. For example, midcap companies that operate in the middle stage of growth usually offer fewer dividends than large cap companies that have reached the pinnacle of their operations.

4. Industry Type – Dividend yield may also vary according to industry because of variations in dividend distribution norms. For example, utilities and consumer staples offer higher dividends than other sectors or industries.

Benefits Of a Good Dividend Yield

A good dividend yield of a company possesses the following benefits:

1. Strong Company Financials – The value of dividend yield provides insights into a company’s financial performance. To provide consistent dividends to its investors, it is crucial for an organisation to maintain substantial profitability and positive cash flows. Therefore, when a listed company offers good and consistent dividends to its shareholders, it can possibly be concluded that it is maintaining a favourable financial position. 

2. Investor Retention – A large set of investors in India prefer participating in the stock market to generate recurring income from dividends. Thus, a company with a stable dividend yield can retain more of its investors because recurring dividends motivate them to stay invested in the company for a more extended period. 

3. Positive Company Image – Companies with a high or consistent dividend yield tend to build a positive image among investors, leading to increased capital inflow from current and new investors.

Taxation on Dividends

Before the Finance Act 2020 was enacted, the dividend income was exempt under the income tax section 10(34) up to Rs 10 Lac. Above the amount of Rs 10 Lac, the dividend was taxable under the section 15BBDA. Also, before this act, the company offering the dividend was liable to pay Dividend Distribution Tax (DDT) under section 115-O at a rate of 15% before paying dividends. 

However, after the Finance Act 2020 was implemented, the above mentioned provisions were abolished. To simplify the tax structure on dividends, the Indian government enacted some significant changes, which are highlighted below:

1. The Dividend Distribution Tax (DDT) was abolished, and the liability to pay dividend tax was transferred from the company to shareholders or the investors receiving the dividends.

2. From the assessment year 2021 – 22, the recipient of the dividend income is liable to pay tax as per their income tax slabs. However, annual dividend income up to Rs 5000 is exempt from tax liabilities.

3. Under this act, the company distributing the dividend deducts Tax Deducted at Source (TDS) if the total dividend amount exceeds Rs 5000 per year. 

Conclusion

While concluding the above blog, we can infer the following:

• Dividend refers to the absolute value of cash flow that investors receive on their investments. These dividends are paid at different intervals during a financial year. In the case of Indian companies, the financial year starts on 1st April and ends on 31st March of the following year. For example, FY24 means fiscal year starting from 1st April 2023 and ending on 31st March 2024.

• Dividends are of various types, such as final, interim, special, and preferred. Each of these dividend types may differ in amounts and carry distinct qualities. 

• Dividend yield is a crucial metric of investment analysis that assists investors in gauging a company’s ability to provide dividends during the investment duration. It represents the relationship between the dividend per share paid and the current market price of one share of a company. 

• To calculate the dividend yield, one has to divide the annual dividend per share by the market price per share. 

• Dividend yield can sometimes be confusing because it uses the current market price as the denominator, making it skewed. An increasing dividend yield does not always mean that the dividend is increasing; it can be a result of a decreasing share price. In contrast, a decrease in the value of dividend yield can result from increased share prices.

• Another essential ratio used to analyse a company’s dividend-paying capabilities is the Dividend Payout Ratio. It differs from dividend yield because it represents the relationship between the annual dividend and net earnings per share. 

• Dividend yield and dividend amounts are influenced by distinct factors such as industry type, economic trend, and financial performance. Investors who invest to earn dividends must analyse these factors before making a decision. 

• In India, dividend income is taxed in the hands of the recipients as per their income tax slabs. As per the new Finance Act 2020, the total dividend income of Rs 5000 per year is exempt, and the amount received more than this is entirely taxable.

Frequently Asked Questions

1. What should be an ideal dividend yield?

There is no ideal range for a good dividend yield. Because yield is a percentage value relative to the current value of shares, it is challenging to decide on a single range. Therefore, investors must analyse a company’s dividend yield based on their requirements, investment goals and expected dividends.

2. Why is dividend yield important?

The dividend yield is important because it helps you in comparing companies across sectors or industries. It is also helpful in benchmarking companies according to the dividends they provide. Therefore, understanding dividend yield and its aspects is crucial for every investor.

3. What are dividends?

Dividends refer to a form of income offered to investors as a portion of a company’s net earnings. Dividends are distributed by companies to their shareholders from their profits after deducting all the expenses. For example, when a company declares a dividend of Rs 2 per share, it means that the shareholders will receive Rs 2 for each share they hold. 

4. How many times a company pays dividends?

The frequency of dividend payments depends on the industry, financial instrument or the asset class chosen for investment. As for the case of Indian listed companies, most offer quarterly or annual dividends, with very few companies or funds paying monthly dividends.

5. Which stocks offer the best dividend in India?

The stock that provides the best dividends in India as per the Trailing Twelve Month (TTM) data are:

*Data is updated as of 3rd January 2025 

6. Is dividend yield fixed?

No, the dividend yield is not fixed. It changes as the dividend value and the market value of shares change. 

7. How are dividends taxed in India?

The dividends earned in India are taxed as per individual’s income tax slabs. However, total dividend income below Rs 5000 per year is exempt from tax implications. After the enactment of the Finance Act 2020, Tax Deducted at Source (TDS) is also applicable, and companies deduct it before paying any dividends.

8. How can I use Univest to invest in high dividend-paying stocks?

You can use Univest’s high-dividend stocks screener to identify and invest in stocks with significant dividend yield. This screener is available on the Univest mobile app and the web. To access it, you can download the mobile application from the Google Play Store and the Apple Store. After downloading the app, you must click on the screener option on the home screen and then access the high-dividend stocks screener.