Before I explain the dividend yield, let me explain what is the dividend. The dividend is simply the amount of money that given to stockholder per year for owning stock on profitable company. This ranging from (0.5 $) to (20$) in some big companies. Once the company make profit each year they divided these profit over the number of shares and the result is dividend. Sometimes companies decided to distribute profit for the shareholders, but Some companies rather then distributed these dividend for shareholder, they either pay their debts which is good or make a new expansion by building new branches in order to increase their sales in future which will lead to increase their profit and (EPS) which is also good.
Dividend yield is a simple calculation which is dividing the dividend that the company distributed to shareholders , by the price of the stocks and multiply the result by 100:
Dividend Yield = ( Annual Dividend / Price of Share) * 100
To use this ratio ( dividend yield) to pick a good stocks, the only thing investor need to know is that when ever this ratio is higher than the average of ( 5 years dividend yield) the better is the company for investment. Because that means this stock which is under studying is undervalued and is a good candidate for selection.
To clarify the idea let assume that we have to companies A and B that have the following information:
|Avg. Dividend yield 5yr||2.5%||2%|
For investors that looking for undervalued company, they will chose company A over B because company A has higher dividend yield than B.
Note: in each ratio used to find undervalued companies has the price of share in the Denominator, always look for higher values.
Dividend yield can be used as (P/E). in order to end up with perfect company you need to compare it with dividend yield of other companies in the same sector as well as the dividend yield of the sector in general. Whenever you find company that had dividend yield higher than other companies and the sector in general, this company its stock price cheap compared to the profit that your are going to make form that price.