Learn How to Calculate Dividend Yield & Understand the 5 Important Lessons of the Inverse Relationship Between Stock Price & Yield, so you can Buy Great Stocks with Higher Yields
Dividend Yield the Critical Measure of Income Investing
First, we will take a 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 so we can 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 it’s most simple form, if you own 1 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.
Dividend Yield Calculation
How to Calculate Dividend Yield – A Practical Example
Here is an example of the Dividend Yield. I own 1000 shares of ABC Company at a 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 thoroughly this concept we will look at a recent char tof Microsoft a lon-time solid dividend payer.
This is a monthly bar chart of Microsoft (Ticker: MSFT) dating back the last 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 at this point is 2.75%, so $30 * 2.75% is a dividend per share of 0.75 cents. What is interesting here is that Microsoft increased their 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 changes in payments made by the company. If the dividend per share is decreased, or even not paid then the dividend yield will go down with the stock price.
As an example, the dividend per share payout for MSFT for May 2017 was $0.36, August 2017 $0.39 and for November 2017 it was $0.42, so they raise the dividend payout.
How to Get the Very 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%. As MSFT is planning to pay out $1.68 (4 quarterly payments of 42 cents) and the stock price is at $100 per share.
3 Big Bonus Rules of Dividend Payments on Long-Term Investments in Successful Companies.
The historical benefit of dividend yield should not be underestimated.
Imaging 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 guaranteeing 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
- Make sure that whatever pushed the stock price lower is not going to 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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