If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock’s expected dividend yield for the coming year?
The correct answer and explanation is :
The dividend yield is calculated as:
[
\text{Dividend Yield} = \frac{D_1}{P_0}
]
where:
- ( D_1 = 1.25 ) (Expected dividend for the coming year),
- ( P_0 = 26.00 ) (Current stock price).
[
\text{Dividend Yield} = \frac{1.25}{26.00} = 0.0481 \text{ or } 4.81\%
]
Explanation:
The dividend yield is a measure of how much a company pays out in dividends each year relative to its stock price. It represents the return an investor can expect from dividends alone, without considering capital gains.
- Understanding Dividend Yield
Dividend yield is crucial for income-focused investors who prioritize consistent cash flows from dividends rather than stock price appreciation. It is often compared to other income-generating investments, such as bonds or fixed deposits. - Why It Matters
- A higher dividend yield may indicate a strong income-generating investment, but it could also signal financial instability if the payout is unsustainable.
- A lower dividend yield may suggest a growth-oriented company that reinvests profits rather than distributing them as dividends.
- Interpreting the 4.81% Yield
- In this scenario, the stock’s dividend yield is 4.81%, meaning for every dollar invested, the investor expects to earn 4.81 cents in dividend income.
- If the company maintains its dividend policy and the stock price remains unchanged, an investor would receive an annual return of 4.81% purely from dividends.
- Total Expected Return
If we consider total return, including capital gains, the expected stock return can be found using the Gordon Growth Model: [
r = \text{Dividend Yield} + g
] [
r = 4.81\% + 4.7\% = 9.51\%
] This means an investor can expect a total return of 9.51% per year, assuming a constant growth rate.