The dividend yield is the current or forecasted dividend expressed as a percentage of the current share price and expressed as an annualized return. Many investors use this metric as the basis for a stand alone investment strategy. This strategy involves buying stocks with a high stable yield that can provide a regular income. These stocks are often perceived as being less volatile than non-paying dividend stocks and are often found in more mature stable industries. REIT stocks however which also pay relatively high dividends as per their rules can be extremely sensitive to changes in interest rates.
Using a historic yield maybe misleading as the dividend may have increased, or in times of economic hardship even reduced. It may be more accurate to multiply the latest dividend by four (if paid quarterly) to find the annual rate. NOTE: some Exchange Traded Funds (ETF’s) pay a dividend semi annually or even annually. It is the responsibility of the trader to ascertain the correct information. The formula for the calculation is as follows
Dividend Yield = Share Price / Annual Dividend
If the latest quarterly dividend is $0.40, the annual dividend can be given as $0.40 x 4 = $1.60. If the stock is trading at $50, the dividend yield is
$1.60 ÷ $25 = 6.40%
If the dividend was recently increased to $0.40, and the previous dividend was $0.32, the trailing 12 month total dividend payment would have been 3 * $0.32 + $0.40 = $1.36. The historic dividend yield would therefore be $1.36 ÷ $25 = 5.44%. Thus, a slightly misleading figure going forward as the expected dividend over the coming 12 months will total $1.60.
Using the Dividend Yield in Merger Arbitrage Trading
Although the dividend, when applicable, is used in the total return calculation when assessing the profitability of merger arbitrage, the yield is not. It is possible to adjust the calculation but usually this is not necessary. Investing in stocks involved in a takeover or merger requires knowing how much or how large the spread is. This value can then be used as an annualized return in the next stage of the calculation.
Merger Arbitrage Limited has written extensively on trading stocks that pay dividends in takeover situations. You can read more in our articles Trading Merger Arbitrage – A Practical Guide and Calculating Stock Based Merger Arbitrage Spreads – Barrick (ABX) & Randgold (GOLD) – An Example.
