Free Cash Flow Yield and Dividend Yield

Dividend yield shows how much cash income a stock pays relative to its price. A stock priced at $50 that pays $2 a year in dividends has a 4% yield. Income investors use dividend yield to compare stocks with bonds and with each other, and some valuation models are built on dividends. But a high yield is not always good news: it can signal that the market expects the dividend to be cut. Understanding payout ratios and dividend coverage helps separate reliable income from yield traps.

The formula#

dividend yield = annual dividends per share / share price

Payout ratio#

payout ratio = dividends per share / earnings per share
FCF payout ratio = total dividends / free cash flow

Typical yields and payout ratios#

Approximate ranges; they vary with interest rates and market levels. The S&P 500's overall dividend yield has generally been around 1.5% to 2% in recent years.

Yield traps#

A yield trap is a stock with a high yield because its price has fallen sharply, often because investors expect a dividend cut.

Dividend growth#

Some investors focus on companies that raise dividends consistently. In the US, the "Dividend Aristocrats" are S&P 500 companies that have increased dividends for at least 25 consecutive years. Dividend growth can signal stable cash flows and disciplined management, though past increases do not ensure future ones. See Growth and Dividend Factors.

Dividend yield and valuation#

The Gordon growth model values a stock based on its dividends:

price = next year's dividend / (required return - dividend growth rate)

Rearranged: expected return ≈ dividend yield + dividend growth rate. A 3% yield growing 5% a year implies about an 8% expected return, if the model's assumptions hold. See DCF Valuation.

Dividends vs buybacks#

Companies can return cash through dividends or share buybacks. Dividends provide steady income and are often "sticky" (companies dislike cutting them); buybacks are more flexible and can be tax efficient in some countries. Total shareholder yield adds dividend yield and net buyback yield. See Buybacks and Dividends.

Dates that matter#

Dividends follow a set calendar: the declaration date, the ex dividend date, the record date and the payment date. To receive the dividend, you must own the shares before the ex dividend date. On that date, the share price typically drops by roughly the dividend amount. See Dividends.

Frequently asked questions#

What is dividend yield?#

Annual dividends per share divided by the share price, showing the income return from holding the stock.

What is a good dividend yield?#

It depends on the sector and interest rates. Yields well above peers can signal risk of a cut rather than a bargain.

What is a yield trap?#

A stock whose high yield results from a falling price that reflects expectations of a dividend cut or business trouble.

Next, learn to value companies from their cash flows in DCF Valuation.