Dividend yield is actually one of the oldest valuation methods. It was very popular back in the days when dividends were the primary reason people owned stocks, and it is still widely used today, mainly among income-oriented investors. Dividend yield is equal to a company's annual dividend per share divided by a stock's market price. For example, a company that pays an annual dividend of $1.00 per share and trades for $20 has a dividend yield of 5% (1/20). If that same stock's price rose to $40 a share, its dividend yield would fall to 2.5%--the more expensive the stock, the lower the yield.
Dividend Yield = (Annual Dividends Per Share) / (Stock Price)
As with all valuation ratios, dividend yield must be used with caution. Stocks with very high dividend yields might seem like bargains, but these companies are often going through financial problems that have caused their stock price to plunge. It's not unusual for companies in such situations to cut their dividend in order to save cash, so their actual dividend yield going forward might be lower than the currently reported figure. Lastly, one major drawback of dividend yield is that it is useless for companies that don't pay a dividend--a group that includes many technology stocks.
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