A dividend yield is a financial ratio that expresses a company's annual dividend payments as a percentage of its current share price. The formula is simple:

Dividend Yield = (Annual Dividends Per Share ÷ Current Share Price) × 100

For example, if a company pays $1.00 per share in annual dividends and its share price is $20.00, the dividend yield is 5.0 percent.

Dividend yields matter to investors for several reasons. First, they provide a measure of the income return an investor can expect from holding a stock, independent of any capital gains. Second, they allow comparisons across different stocks, sectors, and asset classes. A stock yielding 6 percent can be weighed against a term deposit paying 4 percent or a bond yielding 3.5 percent, with appropriate adjustments for risk.

Third, and critically for Australian investors, dividend yields interact with the franking credit system. When a company pays tax on its profits and then distributes those profits as dividends, it can attach franking credits representing the tax already paid. For investors on marginal tax rates below the corporate rate of 30 percent (or 25 percent for base-rate entities), this can result in a tax refund. For investors in low tax brackets or with self-managed super funds in pension phase (taxed at zero percent), the refund can be substantial.

Trailing Yield Versus Forward Yield

It is important to distinguish between trailing dividend yield and forward dividend yield. Trailing yield is based on dividends actually paid over the past twelve months. Forward yield is based on analyst forecasts of dividends expected over the next twelve months. Both are useful, but they can diverge significantly.

A company that recently cut its dividend will have a trailing yield that overstates its current income potential. Conversely, a company that just announced a dividend increase will have a trailing yield that understates future income. Most screeners default to trailing yield, which can be misleading for companies with volatile or recently changed dividend policies.

Gross Yield Versus Net Yield

For Australian investors, the distinction between gross and net dividend yield is equally important. The net yield is the cash dividend received. The gross yield adds the value of attached franking credits. For a fully franked dividend at the 30 percent corporate tax rate, the gross yield is approximately 1.43 times the net yield.

A stock with a 5 percent net yield and full franking has a gross yield of approximately 7.1 percent. This makes a significant difference to after-tax returns.