What Does Yield Mean in Stocks?

What Does Yield Mean in Stocks?
••• wera Rodsawang/Moment/GettyImages

"Stock yield" is the stock dividend yield. To understand what it means, you first must know that a dividend is a profit-sharing payment from a company to its stockholders, explains Investor.gov. Companies announce and pay dividends regularly (usually quarterly). For certain stock market investors, dividend payments are an important incentive to own the stock.

Stock yield is a stock's annual dividend divided by the stock's current price. For example, a stock that pays a yearly dividend of $2 and is currently trading for $50/share has a stock dividend yield (or ‌payout ratio‌) of 4 percent. Stock yields can change any time due to price fluctuations and dividend modifications, but the dividend amount is much more stable than a stock's price. When a stock's yield increases, it becomes more attractive to income-oriented investors.

Understanding Why Stock Yield Is Important

A company's dividend yield is significant because it says something about the stock's market value. Some investors like value stocks (i.e. underpriced stocks), and a high dividend yield may indicate that the stock is currently unpopular (its price is relatively low relative to recent history). Alternatively, its dividend payout may be high, perhaps due to a recent increase.

Since investors must ration their purchases, they may look at high stock dividends as "money in the bank." That is, the higher dividend income is a fixed income component of a stock's total return, independent of its price movements.

Other investors may prefer low-yield stocks; these are often called growth stocks. Instead of distributing profits to the shareholders through dividends, these companies are reinvesting their profits into the company's growth. In the long run, a fast-growing company should be in greater demand, which causes its stock price to increase. A low dividend yield is a positive for growth-oriented investors when coupled with evidence of sustained growth.

Exploring Tax Implications of Dividends

There are tax implications that impact dividends and prices. To start with, dividends come in two flavors:

  • Qualified dividends‌: The IRS says these dividends are taxed at the long-term capital gains (LTCG) rates, which range from ‌0 percent to 20 percent‌ and are much lower than the ordinary tax rates of ‌10 percent to 37 percent‌ (for 2022 and 2023). For a dividend to be qualified, it must be issued by a U.S. corporation that trades publicly on a major exchange. Moreover, an investor must own the dividend-paying stock for at least 60 days out of a 121-day holding period centered upon the ex-dividend date. This is the first date following the declaration of a dividend on which the stock buyer is not entitled to receive the next dividend payment. A stock's price usually drops (at least initially) by the dividend amount on the ex-dividend date.
  • Ordinary dividends‌: Any non-qualified dividend is an ordinary dividend subject to the stockholder's ordinary marginal tax rate.

It's relatively easier to earn the low LTGC rate on qualified dividends than on the sale of stocks, since the latter requires you to hold the shares for an entire year.

Learn to Recognize a Good Stock Yield

Generally, a good current yield is in the ‌2 percent to 4 percent‌ range. Higher yields and greater dividend growth (often seen in real estate investment trusts, or REITs) are great but riskier – the rate may be too high to be sustainable, and the company's board of directors may feel pressure to cut the dividend. For this reason, it's essential to have a holistic investment strategy that doesn't view the quarterly dividend in isolation but rather in concert with the price-to-earnings ratio, share price, earnings per share, net income, interest rates and other metrics.

Don't Confuse Yield With Return

Yield is a component of a stock's total return, which includes the dividends you receive and the gain in the stock's price. It is often expressed as the ratio (called gross return) of profit to investment. For example, you may buy a stock at $100 per share. One year later, the stock sells for $110 per share and paid a $3 dividend during the period. Your gross return is ($110 - $100 + $3) / $100, or 13 percent. Your dividend yield is 3 percent, measured from your stock purchase date. The current dividend yield is $3/$110, or 2.73 percent.

Net return factors in taxes, fees and inflation, so it is lower than the gross return.