Dividend rate is the dollar amount of the dividend paid on a dividend-paying stock. Dividend yield is the percentage relation between the stock's current price and the dividend currently paid.
Dividend rate is another way to say "dividend," which is the dollar amount of the dividend paid on a dividend-paying stock. Dividend yield is the percentage relation between the stock's current price and the dividend currently paid. Both are useful for investors to know, although knowing dividend yield is typically more informative.
Public companies often return some amount of profits to their stockholders. This may be a cash payout in the form of a dividend check, or it may be additional stock in the company. Dividends are decided by the company's board of directors and are drawn on that company's returned earnings account, which is reduced by the amount of the dividend paid.
Ways of Describing Dividends
There are two common ways of describing a dividend. The first, called the dividend rate, is the dollar amount of the annual dividend declared. Note that many companies issue dividend checks quarterly. In that event, the dividend rate is the total of the dividends paid for the four quarters of its fiscal year.
The second way of describing the dividend, called the dividend yield, results from a simple calculation:
Dividend yield = Declared dividends ÷ Current stock share price
For example, a stock with a current share price of $75 pays an annual dividend of $3.25 per share. When 3.25 is divided by 75, it equals 0.0433. The company's dividend yield is 4.33 percent.
Rate or Yield: Which Is Better?
When you're considering investing in dividend-paying stocks, you're almost certainly more interested in their yields than their rates. Here's why: If you have $10,000 you're planning to invest in dividend-paying stocks, you're concerned about how much dividend money you can get out of that $10,000. In the yield equation, Yield = Dividends ÷ Share price, you can solve the equation for yield by multiplying both sides by share price, which in this example results in:
Yield ⋅ Share price (10,000) = Dividends
If the yield is 4 percent, you'll receive dividends totaling $400 on your $10,000 investment. If the yield is 5 percent, you'll receive dividends totaling $500. The higher the average yield of the $10,000 you hold in dividend-paying shares, the more money in your pocket.
If you're retired and hold a percentage of your retirement funds in dividend-paying stocks, your immediate interest may be in the total amount of dividend income you're slated to receive, which is the total of all stocks' dividend rates. That's the money you're planning to live on for the next 12 months.
Even then, over the long run, you're probably going to be more interested in the yield. If you hold $100,000 in dividend-paying stocks in your portfolio and they yield 2.8 percent, by selling the lower-yielding shares and buying another company's higher-yielding shares (assuming the risks are equal), you're going to improve the yield on that $100,000. If you can improve the average yield from 2.8 to 4.0 percent, that's another $1,200 in annual retirement income.
Yield vs. Risk
In the example above, by trading $100,000 in dividend-paying shares yielding 2.8 percent for the same dollar amount of shares yielding 4.0 percent, you increased your annual income by $1,200. In the real world, swapping shares is rarely so simple and requires you to assess the relative risk of the shares you're buying vs. the lower-yielding share you're holding now. Assessing risk can involve several nontrivial calculations.
Fortunately, your online broker's research page has done some basic calculating for you. While the details of risk assessment fill bookshelves, the most basic thing to look for is the stock's beta. This tells you whether the dividend-yielding stock you're thinking of buying fits your risk profile, which is a wonky of saying if holding that stock in your portfolio is a risk you're willing to take.
Comparing Beta Rankings
Somewhere in the research section of your broker's webpages, you'll find that the stock you're contemplating buying has a beta rating. Here's how beta assessments work: If a particular stock rises and falls in price the same as the market, which you can approximate as the S&P 500 index, then it has a beta of 1. Stocks with betas greater than 1 propose a proportionally greater risk than the market average and stocks with betas lower than 1 propose proportionally lower risk.
While there are all kinds of exquisitely complicated calculations an analyst may bring to risk assessment, here's a relatively simple rule of thumb to get you started: If you're considering swapping dividend-paying stock A for stock B because A has a yield of 1.7 and B has a yield of 2.4, take a look at their respective betas before making the trade. If the betas are similar, then B represents a better investment. If the yields are similar, but stock B has a lower beta, it's a better investment than A.
The CAPM Risk Assessment Formula
Assessing beta alone gives you a good head start on risk assessment, but it doesn't give you a way of determining whether, for example, Stock A with beta 0.7 and a yield of 3.8 is a better investment than stock B with a beta of 0.6 and a yield of 3.5. The way of doing this is called the Capital Asset Pricing Model. An explanation of the CAPM formula goes far beyond the scope of this article, but here's the essential info you need to know:
- You can look up the CAPM for any exchange-listed stock online by Googling "CAPM [stock name]"
- By comparing the CAPM's of two stocks, you can determine which of the two represents a better investment – the higher return when systemic risk is also taken into account. Systemic risks are market risks beyond the risk in a specific portfolio of stocks. The prevailing interest rate is one example of systemic risk.