How to Change Calculations on Dividend Yields

by C. Taylor

Dividend yield describes a stock's annual dividend distribution as a percentage of its current share price.The annual growth rate of dividends describes the average increase in annual dividend payments. If you know the annual growth rate, you can modify the dividend yield calculation to produce the yield required to meet an expected return. Armed with this required dividend yield, the standard dividend yield calculation locates the stock price that produces this return.

Divide the annual dividend payments by the current stock price to calculate dividend yield. Your investment broker can provide this information to you, or you can consult online financial websites, such as money.cnn.com, finance.yahoo.com or google.com/finance. The formula is presented as: Dividend Yield = Dividends / Stock Price As an example, for a $75 stock that offers $3 in annual dividends, divide $3 by $75 to calculate the dividend yield of 0.04, or 4 percent.

Modify the Gordon Growth Model to calculate the dividend yield. The Gordon Growth Model calculates the stock's value with respect to dividends, but modifying it allows you to calculate a required dividend yield. The formula is modified as: Stock Price = Dividends / (Required Investment Return - Dividend Growth Rate) Dividends / Stock Price = Required Investment Return - Dividend Growth Rate Because you already know that dividing dividends by the stock price calculates the dividend yield, the formula is modified to: Dividend Yield = Required Investment Return - Dividend Growth Rate As an example, if you wanted an investment return of 8 percent and the dividend growth rate was 3 percent, subtract 3 from 8 to calculate the required dividend yield of 5 percent. Your desired investment return is subjective; it may match an alternative risk-free investment return, the rate of inflation or any desired figure.

Modify the standard dividend yield calculation to solve for the stock price. The formula becomes: Stock Price = Dividends / Dividend Yield Divide the required dividend yield into the annual dividend amount to calculate the stock price. In the example, for a required dividend yield of 5 percent and annual dividends of $3, divide $3 by 0.05 to calculate the stock price of $60. The current price of $75 does not meet this expectation. If the current price was under $60, you would achieve a better-than-required dividend yield.