Key takeaways

• A Dividend is a portion of profits given back to the shareholders that can help increase investor loyalty, boost the stock price, and make good use of extra cash for the company.

• Dividend Yield = Annual Dividends Per Share / Stock Price Per Share * 100%

• Stocks with a strong dividend payout history are usually from mature companies with stable earnings and can act as a hedge against stock market volatility.

Understanding dividend yield

Companies normally distribute a portion of their profits as dividends while retaining the remaining amount to reinvest in the business. 

The dividends may be paid in cash or additional shares of stock. Most dividends are paid quarterly, and some are paid monthly, annually, or even in the form of a special dividend. 

Dividends can bring many benefits, such as increasing investor loyalty, boosting the stock price, and making good use of extra cash for the company.

The dividend yield is the financial ratio that measures the amount of cash dividends paid to shareholders relative to the stock price per share. 

It's calculated by dividing the annual dividend paid per share by the stock price per share.

Dividend Yield

= Annual Dividend Per Share / Stock Price Per Share * 100%

= Earnings Per Share * Dividend Payout Ratio / Stock Price Per Share * 100%

= (1/PE Ratio) * Dividend Payout Ratio * 100%

From the equation, we can tell that dividend yield is positively related to the dividend payout ratio and negatively related to the PE ratio.

Therefore, the high-yield dividend stocks usually refer to those with high dividend payout ratios and low PE ratios.

However, investors should be aware of extremely high dividend yields, as they may result from an unreasonably low PE ratio or unsustainable dividend policy.

The rationales behind investing in dividend stocks

The main purpose of a high dividend yield portfolio is not to outperform the broad market but to generate a passive income stream. 

In general, stocks with a strong dividend payout history are from mature companies with stable earnings, which are less susceptible to large swings in the market. They may act as a hedge against economic or political uncertainty and stock market volatility.

However, generally, not all dividend stocks are great investment choices. When considering dividend stocks, also consider other parameters are included, such as a sustainable business model, a long track of profitability, rising cash flows, good liquidity, or a strong balance sheet.