The main thing to look for in choosing income stocks is yield: the percentage rate of return paid on a stock in the form of dividends. Looking at a stock’s dividend yield is the quickest way to find out how much money you’ll earn from a particular income stock versus other dividend-paying stocks (or even other investments, such as a bank account).
Dividend yield is calculated in the following way:
Dividend yield = dividend income / stock investment
When you see a stock listed in the financial pages, the dividend yield is provided along with the stock’s price and annual dividend. The dividend yield in the financial pages is always calculated as if you bought the stock on that given day.
Based on supply and demand, stock prices change every day (almost every minute!) that the market’s open. If the stock price changes every day, the yield changes as well.
Take a look at the following table. If you bought stock in Smith Co. a month ago at $20 per share with an annual dividend of $1, your yield is 5 percent. But if Smith Co. is selling for $40 per share today, the yield quoted would be 2.5 percent. Did the dividend get cut in half?! Not really.
You’re still getting 5 percent because you bought the stock at $20 instead of the current $40; the quoted yield is for investors who purchase Smith Co. today. Investors who buy Smith Co. stock today would pay $40 and get the $1 dividend; the yield has changed to 2.5 percent, which is the yield that they lock into.
So, while Smith Co. may have been a good income investment for you a month ago, it’s not such a hot pick today because the price of the stock doubled, cutting the yield in half. Even though the dividend hasn’t changed, the yield has changed dramatically because of the stock price change.
| Investment | Type | Investment Amount | Annual Investment Income (Dividend) | Yield (Annual Investment Income / Investment Amount) |
|---|---|---|---|---|
| Smith Co. | Common stock | $20 per share | $1.00 per share | 5% |
| Jones Co. | Common stock | $30 per share | $1.50 per share | 5% |
| Wilson Bank | Savings account | $1,000 deposit | $40 | 4% |
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Source:http://www.dummies.com/how-to/content/how-to-calculate-the-yield-of-your-income-stock-in.html
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