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Dividend Yield Calculation and Drawbacks

Many investors prefer to buy stocks of companies that pay dividend. They mostly prefer it if their intentions are to keep the stock over the long-term.

Dividends represent a current income, which if added to price appreciation may lead to growth, which in turn adds further to your profits. On the other hand, if you are wise enough you will reinvest the dividend. You will deprive yourself of the current income, but you will gain further dividends in the future to come.

In order to evaluate whether a particular stock represents a good investment in dividend terms, investors often use dividend yield as a measurement. It represents the percentage that the stock returns as compared to its price.

Dividend Yield Calculations

The formula for the calculation of dividend yield is as follows:

Dividend Yield = Annual Dividend per Share / Stock's Price per Share

Dividend Yield Formula Drawbacks

The more observant of you have noticed that the denominator of the formula includes the price per share of the stock. This may have tricky result on the yield dividend since a decrease in the price, which at the same time is accompanied by a dividend of the same value as before leads to an increase in the dividend yield.

Dividend Yields as a Stock Selection Criterion

In order to find a company that pays high dividend yields, you can use the services of different stock screens, such as Morningstar.com.

Dividend yield should represent only one of the criteria for selecting a stock for investment. You should not depend only on it and use other measurements in evaluating the potential profitability of a stock because a high dividend yield company not always guarantees you that in the future you will enjoy these high dividends.

Generally, dividends are paid from the earnings that the company makes and then it is paid in cash to its shareholders. Still, there are many cases in which the company has made an acquisition and has used a debt to cover for it. Under such conditions you should try to find the means by which the company will repay the debt and how this will reflect on the cash availability of the company.

So, when you select a company you should check not only its dividend yield, but also history of steady growth and earnings and predictions on the revenue growth.

Final Piece of Advice

When you pick a stock, pay attention not only to its dividend yield, but also to its other fundamentals. This is required for since a high dividend yield may be misleading and may result in an unsuccessful investment decision.

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