Learn How to Calculate Dividend Yield & Understand the 5 Important Lessons of the Inverse Relationship Between Stock Price & Yield so that you can Buy Great Stocks with Higher Yields.
Dividend Yield: A Critical Measure of Income Investing
First, we will look at what is a dividend, and some of the advantages of buying stocks for dividends, then we will take a close look at the Dividend Yield and how to calculate it.
Lastly, we will explore the relationship between a stock’s price and the dividend yield to get a good idea of when to invest in any particular stock to maximize our long-term dividend gains.
What is a Dividend?
Of the 6000+ stocks currently available to purchase on the major U.S. indexes, circa 2800 companies currently offer a dividend payout.
A dividend is an offer from the company, confirmed by the board of directors, to pay out a portion of its income (after-tax profits) to its shareholders.
These companies tend to be well established with a stable income stream, enabling them to offer a constant & consistent dividend.
The dividend is essentially a cash reward to the shareholder for holding the stock.
If managed well, you can also ensure you pay a minimum, if not zero tax on your dividend earnings.
What is Dividend Yield?
The dividend yield is essentially the “Percentage Payment you will receive from the company whose shares you hold in relation to the price you paid for the stock.”
In its most simple form, if you own one share of company ABC, and you paid $100 for that share, and the company’s dividend yield is 2%, you will expect to get $2.
The important this here is that the dividend yield varies with the stock price, so depending on what price you paid for the stock, that will be your yield.
The Dividend Yield Calculation
Example: How to Calculate Dividend Yield?
Here is an example of the Dividend Yield. I own 1000 shares of ABC Company at the cost of $10 per share; this equals $10,000 invested.
ABC pays out a regular dividend of $0.50 per share. As a single share of the company is worth $10, $0.50 equates to a dividend yield of 5%.
This 5% is essentially what you earn on your money regardless of stock price growth.
Of course, if the stock price deteriorates during the period in which you hold the stock, this may mean your net profit reduces. For example, you make a 5% profit in terms of dividend yield, yet the stock price has depreciated 5%.
This means your net profit if you were to sell would be Zero.
5 Critical Lessons on the Inverse Relationship of Dividend Yield vs. Stock Price
What most people do not understand is the inverse relationship between dividend yield and the stock price. As a stock price goes down, the dividend yield goes up.
To understand this concept thoroughly, we will look at a recent char of Microsoft, a long-time solid dividend payer.
This is a monthly bar chart of Microsoft (Ticker: MSFT) dating back 13 years to 2005. The Candlesticks are the Stock Price, and the Green Filled Line Chart is the Dividend Yield.
A first glance, you can see that when the stock price falls, the dividend yield peaks, and when the stock price hits a top, the yield falls.
Points on the Chart:
- During the financial crisis (2009), MSFT his a low of $15. If you had purchased the stock at this point, you would have received a dividend yield of 3% (see point 2
- Here you see the dividend yield has spiked at 3%; this is because of the relationship between stock price and the dividend payment. If the dividend yield is 3% on a $15 stock price, then the dividend payment per share was in 2009 ($15 * 3%) 45 cents.
- In quarter 2 in 2013, Microsoft’s stock price has doubled to $30
- At the same time, the dividend yield is 2.75%, so $30 * 2.75% is a dividend per share of 0.75 cents. Interestingly, Microsoft increased its dividend payment per share during this period, ensuring the stock was still prized by income investors.
- So, although the relationship between the stock price and the dividend yield is mostly inverse, it does vary because of the company’s changes in payments. If the dividend per share is decreased or even not paid, the dividend yield will go down with the stock price.
For example, the dividend per share payout for MSFT for May 2017 was $0.36, August 2017 $0.39, and November 2017, it was $0.42, raising the dividend payout.
How to Get the Best Yields on Great Stocks
As we have seen, during the last 13 years, the dividend yield on MSFT has varied between 1% in 2005 and over 3% in 2013. That is a dividend income difference of 300%.
Don’t forget the actual yield you will get on a stock depends on when you purchased the stock.
If you purchased the stock today (the most right point on the chart), the dividend yield would be 1.68%. MSFT plans to pay out $1.68 (4 quarterly payments of 42 cents), and the stock price is at $100 per share.
3 Bonus Rules of Dividend Payments on Long-Term Investments in Successful Companies.
The historical benefit of dividend yield should not be underestimated.
Imagine you had purchased the Microsoft shares when the stock price was $15, and you kept them all the way until today. This year you would have earned $1.68 per share.
So, your personal dividend yield based on the stock price of $15 would be:
Annual Dividend $1.68 / Stock Price $15 = Dividend Yield of 11.2%
So, anyone who buys MSFT today would get 1.68%, but you would be getting 11.2%; that is something worth understanding.
Would you sell a stock that was almost guaranteed to net you 11.2% per year in profit?
I would not.
3 Dividend Yield Rules to Remember:
- Buy dividend stocks when the price is artificially low.
- Ensure that whatever pushed the stock price lower will not intrinsically damage the long-term business profits.
- Always remember your personal dividend yield is based on the price you paid for the stocks.
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