A stock's dividend yield is computed by taking the indicated dividend—the expected dividend over the next year—and dividing it by the share price. For most stocks, the indicated dividend is the most recent quarterly dividend multiplied by four, although some firms have switched to a single annual dividend payment. If a stock is paying an indicated dividend of $1 per share and is trading with a price of $40, its dividend yield is 2.5% ($1 ÷ $40 = 0.025, or 2.5%). If a stock's price rises faster than its dividend, the dividend yield will fall, indicating that the price may have been bid up too far and may be ready for a decline. Conversely, if the dividend yield rises to a high level, the stock may be poised for an increase in price if the dividend can be sustained.

The Dividend-Yield Strategy

Like all basic value-oriented techniques, the dividend-yield strategy attempts to identify investments that are out of favor. Contrarian techniques such as this are based on the premise that markets tend to overreact to good and bad news and push the price of a security away from its intrinsic value. Value investors hope to identify these mispriced securities through the use of a consistent set of rules called a valuation model.

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