Forward dividend yield: What it is and how to use it 

As an investor, it pays to be aware of the forward dividend and yield and how to calculate forward dividend yield. This article will explain the forward dividend yield and how to use it when analyzing stocks effectively.  

Understanding forward dividend yield

Since a stock's price is always dynamic and moving, the dividend yield can change with the value of the stock. The dividend yield can also change when companies raise or cut quarterly dividends, affecting its forward annual dividend rate. An annual dividend yield is based on the dividends paid in the past year divided by the current stock price. A forward dividend yield estimates the expected dividend yield in the upcoming year. Knowing the forward dividend yield of a stock can be helpful when evaluating potential stocks for income purposes. The forward dividend yield expresses the return on investment (ROI) for holding the stock for a year. 

As a newer investor, it’s important to recognize the difference between a stock’s forward dividend yield and its trailing dividend yield. The trailing dividend yield is calculated based on the dividends paid by a company in the past year. For example, if a company paid a total of $2 in dividends over the past year and the current market price of its stock is $70, you could calculate the trailing dividend yield by dividing the total dividends paid last year ($2) by its current share price ($70). In this example, the trailing dividend yield equals about 2.9%. 

By contrast, the forward dividend yield is based on future dividend projections rather than historical data. Investors and analysts may examine a company's financial data, including past information on dividend payments, revenue and debt levels to estimate what a company will pay out to its shareholders in the next year. Simple calculations extend the most recent dividend payment throughout the coming year, rather than a more complex estimate. Using this projection, analysts divide the payment by the share price to calculate forward yield. 

Consider this difference as you consider the historical context of potential investment opportunities. You may want to put more weight into historic dividend values than forward yields, as these figures consider actual past payments when estimating your future earnings. 

Forward dividend yields that use only the most recent dividend in their calculation may also lead investors into dividend traps more frequently. Be sure to thoroughly research debt levels and revenue trends to determine which dividends are sustainable for long-term holdings. 

Factors influencing forward dividend yield

Understanding the factors that play a role in each stock’s dividend payment and yield calculation can help you better locate the best investment options for your goals. Some major economic factors that influence dividend yield rates include the following. 

• Interest rates: When interest rates are low, investors seek higher-yielding investments like dividend-paying stocks for income. Conversely, when interest rates rise, fixed-income investments become more attractive, potentially decreasing demand for dividend stocks and affecting their yields. If you're currently in a high-interest environment, assets with higher forward dividend yields are more likely to be overvalued. 
• Inflation: Inflation erodes the purchasing power of money over time. Companies may adjust their dividend payments to maintain or enhance their real-time, inflation-adjusted value to compensate for this. Be sure to monitor dividend increase announcements in the context of your current inflation environment, and make sure that revenue trends can also support rising payments. 
• Sector trends: Different industries have varying norms regarding dividend payouts. Mature and stable industries, such as utilities and consumer staples, often have higher dividend yields, reflecting their stable cash flows. In contrast, technology or growth-oriented sectors might have lower dividend yields as companies reinvest more earnings for future growth. Understand that high dividends are often offered at the expense of growth or expansion, providing higher returns and income now. 

A company’s payout ratio is a key metric to consider when considering future dividend payments. The payout ratio is a figure that defines dividends related to earnings; a lower payout ratio suggests that a company has more room to increase dividends in the future. Conversely, a higher payout ratio indicates that a larger percentage of a company’s profits are being paid out in dividends, which could signify the need for a future cut. 

How to calculate dividend yield

To calculate a forward dividend yield, you take the most recent dividend payout amount, annualize it and divide it by the current share price. For example, if XYZ pays a 25-cent quarterly dividend, the annual dividend is $1. 

Divide the annual dividend payout of $1 by the current stock price of XYZ at $20, resulting in a forward dividend yield of 5%. The exact dividend yield will vary as the underlying stock price fluctuates, and the company may raise or lower its dividend. Therefore, forward dividend yields are an estimation, but it's important to learn to calculate yield forward. 

Importance of dividend yield

A dividend yield is significant because it shows how much income you can collect from holding stock. It's a measure of ROI. You can use the dividend yield to determine how much income you will receive for holding a stock or how much of a hedge you may have against market volatility. For example, if a $100 stock has a $2 annual dividend, you can expect a 2% dividend yield. You can also expect a 2% safety buffer on volatility during the year. Dividend yield provides an income stream in addition to capital appreciation. 

If the underlying stock price falls, the dividend yield increases, and vice versa. Dividend stocks, especially dividend aristocrats, tend to have less volatility. Dividend yield helps investors evaluate stocks for potential income, valuation and volatility. 

Difference between forward, indicated and trailing dividend yields 

There are different measures of a company's dividend payouts. These measures vary by how you calculate them, considering different periods and assumptions on future dividend payments. Here are three different types of dividend yields:

• Forward dividend yield: Forward dividend yield is the expected dividend payout for the future year. You can calculate it by dividing the estimated dividend payments for the next 12 months by the current stock price. For example, XYZ just raised its annual dividend to $1, and the stock trades at $50.The forward dividend yield would be the $1 annual dividend payout divided by the $50 stock price, which produces a 2% forward dividend yield. 
• Indicated dividend yield: Indicated dividend yield measures the annual dividend payout based on the most recent dividend payment, calculated by annualizing the most recent dividend payment and dividing it by the current stock price. For example, XYZ paid a 15-cent dividend last quarter, and the stock is trading at $50. The annualized dividend payment of 60 cents is divided by the $50 share price to produce a 1.2% indicated dividend yield. 
• Trailing dividend yield: Trailing dividend yield is based on total dividends paid out in the prior 12 months as a percentage of the current stock price. For example, XYZ raised its dividend every quarter, resulting in actual quarterly dividend payments of 22 cents, 25 cents, 29 cents and 33 cents in the prior year. The trailing 12-month dividend payments total $1.09, divided by the current stock price of $50, producing a 2.18% trailing dividend yield.

The MarketBeat dividend yield calculator comes in handy when calculating the various dividend measures.

Strategies for maximizing forward dividend yield

Knowing the risks associated with forward dividend yield calculation can help you create strategies to hedge against potential cuts. 

• Diversification: Diversifying investments across various sectors and industries can help mitigate risks associated with specific economic or market conditions, as various sectors may respond differently to economic fluctuations. By spreading investments across a diverse portfolio of dividend-paying stocks, investors can capture a range of yields across multiple stages of the economic cycle. 
• Dividend Aristocrats: "Dividend Aristocrat" is a title awarded to companies that have raised their dividend payment annually for at least 25 years. Investing in these companies provides confidence in the reliability and sustainability of dividend payments. These stocks usually also represent major market names, offering share value stability. Marketbeat offers a current list of Dividend Aristocrats for you to explore. 
• Reinvestment plans: Dividend reinvestment plans (DRIPs) allow investors to automatically reinvest their dividends back into additional shares of the same stock as they are paid. This compounding effect can significantly enhance the overall forward dividend yield over time — as the number of shares increases, so does the potential for future dividend payments. Enabling DRIPs also helps with cost-averaging, a cost-effective strategy that helps you access a lower average price-per-share by investing throughout the year instead of timing the market. 

Dividend safety

While many investors assume dividends are a safe income source, they overlook that the underlying stock can depreciate. For this reason, understanding the underlying stock's fundamentals is essential. 

Excessively high 10% or higher dividends may seem like no-brainers for investing, but there is a reason for a high dividend yield. It's likely because the stock's price may be too low. Cheap stocks tend to be cheap for a reason. There's usually a problem with the business that has gotten investors to sell, thus depressing the share price and boosting the dividend yield. 

Stocks with double-digit annual dividends tend to be companies facing financial difficulties that may result in a cutting or eliminating the dividend or even bankruptcy. It's always crucial to research and protect your principal investment in the stock before considering how much money you can earn from a dividend. Risk is proportionate to the reward in the stock market. For this reason, most dividend aristocrat stocks tend to have lower-yielding dividends than riskier stocks for a reason. Comparing dividends to a risk-free interest-bearing asset like FDIC-insured certificates of deposit (CDs) is also essential. 

When interest rates rise, it's common to find risk-free investments like CDs that pay more than dividend stocks. While you may not reap the rewards of capital appreciation if the stock price rises, you are free from the risk of capital depreciation if the stock price falls.