When calculating dividend yield, it is calculated as a percentage of the annual dividend per share of a stock in relation to the current price of the stock.
There are two methods used in measuring dividend yield and they include trailing dividend yield and also indicated dividend yield.
A Little More on What is Dividend Yield
The difference exists in the yield formula’s numerator which involves the use of the indicated dividends or trailing dividends over a certain period. Trailing annual dividends refer to the sum of the dividends which are supposed to be paid out over the next twelve months. Usually, indicated annual dividends are calculated as the latest dividend payments multiplied by the dividend distribution frequency. The major difference between trailing annual dividends and indicated annual dividends is the fact that while the former is backward-looking, the latter is forward-looking.
At this point, this question arises, in what market type is it suitable to utilize a type of dividend yield against the other? The answer lies in dividend payment consistency. It is discovered that the consistency of dividend payments differs from country to country and also by region. In markets where companies are unstable in dividend payments, especially when it comes to regular payout amounts or payout schedules, a trailing dividend yield measure is better. The calculation of trailing annual dividend yield shows the realized information since there has been the occurrence of dividends already.
But, when there is an advance knowledge or stability of the frequency and timing of dividend payments, using indicated dividends can capture all upcoming increases or decreases. Hence, the indicated dividend yield has a better reflection of the future income an investor will get at the end of a period. The dividend yield calculated by indicated or trailing methods may not have much difference for a fully developed company whose dividend policy is rarely changed. However, during financial stress periods, when there is an occurrence of major dividend cuts or eliminations, a company might have a trailing dividend yield but could have 0% as its indicated dividend yield.
Difference Between Forward & Trailing Dividends
Purchasing a stock which pays dividends gives a financial return even before selling your shares. In a situation where you have 500 shares and the payment of the stock is at $1-per-share dividend each quarter, that is a pre-tax investment income of $2,000 a year. One measure used when shopping for dividend stocks is the yield which refers to dividend size divided by the price of the stock. Two ways of measuring and comparing yields are forward and trailing dividend yields.
Trailing yield analysis calculates dividend yields the normal way by checking the average dividends of the stock over the past year. In a situation where a $120 stock pays the sum of $1.20 in two quarters and also $.60 in two quarters, the total dividend for the year is $3.60. Then divide the per-share price into the dividend in order to get the yield, which in this context is 3%. Measuring trailing yields for various stocks allows you to compare dividend performance irrespective of the price per share.
The opposite approach is taken by the forward dividend yield in that it figures how much of a dividend you can earn in the future. It is easy in a situation where the company has made known its planned dividends for the year. If it hasn’t, thanks the final dividend of the company from the previous year and assume that rate continues. In a case where the dividend for the fourth quarter was $1.20, you can forecast that the subsequent four quarters would generate a total of $4.80 which is a 4% yield on a $120 stock.
Trailing yields does not involve guesswork in that the dividends are already out, hence making you know the yield. Forward dividend yields that are based on the previous year’s dividends could be close to a guess. This is because, the Seeking Alpha website discovered that if you invest in the top ten dividend stocks of NASDAQ, for instance, 7% was the margin of error.
References for Dividend Yield
Academic Research on Dividend Yield
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A longer look at dividend yields, Goetzmann, W. N., & Jorion, P. (1995). Journal of Business, 483-508.
International evidence on the payout ratio, earnings, dividends, and returns, Ap Gwilym, O., Seaton, J., Suddason, K., & Thomas, S. (2006). Financial Analysts Journal, 62(1), 36-53.
Does dividend policy foretell earnings growth?, Arnott, R., & Asness, C. (2001).
Does the “Dow-10 Investment Strategy” Beat the Dow Statistically and Economically?, McQueen, G., Shields, K., & Thorley, S. R. (1997). Financial Analysts Journal, 53(4), 66-72.
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Selecting internet company stocks using a combined DEA and AHP approach, Ho, C. T. B., & Oh, K. B. (2010). International Journal of Systems Science, 41(3), 325-336.
Investor response to a reduction in the dividend tax rate: Evidence from the Jobs and Growth Tax Relief Reconciliation Act of 2003, Lightner, T. A., Morrow, M., Ricketts, R. C., & Riley, M. E. (2008). Journal of the American Taxation Association, 30(2), 21-46.
Mining fool’s gold, McQueen, G., & Thorley, S. (1999). Financial Analysts Journal, 55(2), 61-72.
Dividend persistence and return predictability, Powell, J. G., Shi, J., & Smith, T. (2004).