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Monday, January 17, 2011

Dividend Yield Helps You Compare Buying Opportunities

Dividend yield (also called stock's yield) can help you compare two or more investing opportunities by applying a common measurement.

You can calculate a stock's dividend yield by dividing the company's dividend (the annual amount, not individual payments) by the current market price.

This tool gives you a snapshot of how several companies compare at a given moment. Since it uses the current market price, the value changes every time the stock's price does. This is important because if you are looking at two stocks, one rising and one falling, the numbers will change. The lower the stock's price, the higher the yield will be and, conversely, the higher the price, the lower the yield.

There are a couple of things to remember about a stock's dividend yield.

First, this is not a "silver bullet" metric, meaning don't base an investment decision on this factor alone. One obvious problem with a stock's yield is that the lower the price falls the higher the yield appears (assuming the dividend remains unchanged).

At some point, the company could become worthless or sink so low (because of other fundamental flaws) that it won't recover any time soon, if at all. Some time before that happens, the company will undoubtedly reduce or eliminate its dividend.

Second, once you buy the stock, you lock in the yield at the purchase price and you continue to receive that yield until you sell the stock. In the meantime, the stock's price can rise and fall changing the yield for future investors.

For example, if you buy a stock with a Rs. 3 annual dividend for Rs. 35 per share, your yield is about 8.6%. As long as the dividend remains the same, this is what your stock yield will be. It makes no difference what the stock's price does.

Use the dividend yield to compare two or more stocks, but don't rely on it as the sole factor in deciding which stock to buy.