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Dividend Yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a given stock.

Dividend yield is calculated by dividing the annual dividend paid per share by the current market price of a share and can be used to decide which stock will give a better return on capital.

For example, if two companies both pay annual dividends of £1 per share, but shares in Company A are trading at £20 while shares in Company B are trading at £40, then Company A has a dividend yield of 5% while Company B is only yielding 2.5%. Thus, assuming all other factors are equivalent, an investor looking to supplement his or her income would be likely to buy shares in A rather than in B.

Of course this totally ignores the potential for capital gains by the shares increasing in price but if an investor is primarily looking for income then Dividend Yield will be an important indicator of what to buy.

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