Discover how to calculate dividend yield as an important part of the process of picking the best stocks to boost your portfolio returns

Dividend yield is calculated as the total annual dividends paid per share, divided by the current stock price. Movements in the stock price will change the dividend yield.

Learning how to calculate dividend yield gives you a vital piece of investing information. The dividend yield is one of the important ratios to calculate for dividend-paying stocks. When you’re looking for income-producing stocks, dividend yield is typically a top consideration.

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Part of learning how to calculate dividend yield is watching out for unsustainably high yields

A high dividend yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling share price makes a stock’s yield goes up (because you still use the latest dividend payment as the numerator to calculate yield—but the denominator, the price, has dropped). But when a stock does cut or halt its dividend, its yield collapses.

A classic case is the now defunct Yellow Pages Income Fund. When it first issued units in 2003, it was widely trumpeted by brokers and in the media as a well-established company (although we viewed it as the over-the-hill division of a formerly well-established company).

The company stayed in the limelight even though its high dividend yield—consistently above 10%—was a big warning sign. We never recommended the shares of Yellow Pages Income fund, advising investors to stay away from them.

In August 2011, the company’s credit rating was downgraded to junk status; in September 2011, it cut its dividend altogether. By then the yield was above 30%. The company has since restructured to cut its massive debt and re-emerged as Yellow Pages Ltd.—but the original shareholders of Yellow Pages Income Fund got nothing in the reorganization.

Go beyond learning how to calculate dividend yield, so you can select high-quality stocks

When looking for the best Canadian dividend stocks, avoid the temptation of seeking out stocks with the highest yields—simply because they have above-average yields. That’s because—as we mentioned earlier—a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high dividend payout that has been maintained or raised during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

A track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will most likely be profitable for you in the future.

Invest in dividend stocks with a history of success for better results

One of the best ways of picking a quality Canadian dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one thing that all the best dividend stocks have in common.

We look for Canadian dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.

Canadian dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend payers. That’s why the majority of your stocks should be dividend-payers at all times. As you get older and closer to retirement, you should raise the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.

As an aside, over long periods, you’ll probably find that a third of your stocks do about as well as you hoped, a third do better, and a third do worse. This is partly due to that random element in stock pricing that we’ve often mentioned. It also grows out of the proverbial “wisdom of the crowd.” The market makes pricing mistakes and continually reverses itself. But the collective opinion of all individuals buying and selling in the market eventually beats any single expert opinion.

Use our three-part Successful Investor approach to select the best dividend-paying stocks

1. Invest mainly in well-established, dividend-paying companies;
2. Avoid or downplay stocks in the broker/media limelight;
3. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).

Have you ever bought a high-yield dividend stock only to sell it right before it dropped? What influenced your decision?

Is there a factor other than dividend yield that you find best characterizes the quality of a stock?