Dividend yield is probably the most popular valuation metrics used in assessing the value of a stock. It relative simplicity is also akin to the way the formula is derived and its similarity with other ways of measuring return on investment. But are we actually calculating dividend yield the right way?
Gross Dividend Yield
Before I respond, lets first determine how dividend yield is calculated in most investment websites including Nairametrics. We basically divide the most recent gross dividend per share over the market price of a stock at any given time. So, if a stock paid N10 in dividend and the stock is currently trading at N100 the dividend yield is effectively 10%. With due respect, this is not a smart way to calculate dividend yield. In fact you should only use this as a guide at best but never enough to make an investment decision.
Factor in fees and taxes
The reason for this is a set of assumption the simplistic method uses. It assumes the dividend is tax free and that the share price excludes fees. When you buy shares you pay fees which typically cost about 1.86%. So basically a stock trading at N100 per share will cost you N101.86 after you buy it. Also, before you are paid dividend the company deducts 10% withholding tax from your dividends. So the N10 per share dividend is actually N9 (after deducting 10% WHT). These are all true cost which you must factor when you want to buy stocks for dividend purposes.
Net Dividend Yield (The right way to calculate it)
Let us illustrate using the example above a share price of N100 and gross dividend of N10. My dividend yield would be 8.84% (9/101.86) which is 13.17% smaller than the 10% dividend yield earlier mentioned. It might seem small on the face of it but it is worth noting especially when you add other factors which I will discuss in another blog post.
Finally
The market uses gross dividends because it is easier and avoids having to always factor in fees and taxes all the time. A smart investor however, has to calculate it the right way and ensure all your cost are factored in. It is a better way to measure value for your money
[Read Also: Three quick ways to find out if a stock is overvalued]
