Although I am a big fan of dividends, I don’t care about the investment’s yield. You may think this is contradictory, but hear me out. There are many things I consider when investing, and while seeing the yield is nice, it is the number behind it that really make the difference for me.
What is Yield?
First, yield is the percentage an investment pays out, and it is calculated by dividing the security’s income per share by its share price. Therefore, as the price of the security goes up, the yield goes down – and the inverse is true as well.
As often as a security’s price moves, so does the yield. So, as is the case with stocks, the yield changes daily.
Why The Yield Can Be Misleading
I consider the yield to be misleading because it is a calculation based on the stock price. Just like past returns can’t be a gauge of future returns, the yield itself means nothing as the stock price changes.
Second, the yield doesn’t tell you anything about how much income you will earn in the future. Since it changes everyday, you cannot necessarily calculate your future returns using yield alone.
Also, if you are investing a in a dividend paying stock, you need to remember that the Board of Directors of the company declares the dividend as often as they see fit. Some companies only declare dividends every now and then, where other declare it very regularly – monthly or quarterly. You need to do a little homework beyond just the yield to get to the real picture of yield.
Finally, high yields are not necessarily a good thing. For example, as stock prices fall, yields go up. You need to ask yourself why the stock price is falling. If it is because the company is having a cash flow issue, that high yield may quickly turn to 0%, as the Board of Directors can’t pay a dividend.
What Really Matters For Yield
What really matters for calculating how much you will get is the first part of the equation for yield: income per share. If you are investing, that is all that matters. For example, if the yield is $1.00 per share, and you own 100 shares, you will get $100. It doesn’t matter if the yield is 0.01% or 10% – $1.00 per share is still $1.00 per share.
Second, you need to look at consistency of the dividend payment. Has the company paid 300+ consecutive dividends, or this this just a special payout. The longer the track record of dividend payments, the more likely the company is to continue this trend. As a result, you can be more certain in the income you will receive.
As a side note – a high yielding investment can be an interesting investment because sometimes you want investors to drive the yield down. Remember, as the yield drops, the price of the investment rises. So, not only will you your payment, but you will see a nice increase in the principal value as well.
Readers, what are your thoughts on dividend yields? Do you care?
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This post was written by...
Robert – who has written 317 posts on The College Investor.
Robert is the founder and editor of The College Investor, a personal finance site dedicated to young adult and college student finances. You can learn more about him here and connect with him on Twitter or Facebook.
{ 17 comments… read them below or add one }
A market dip can push yield into crazy territory, in the high double digits. But I agree that a quickly rising yield can spell different kinds of trouble. I have one such case with a shipping company I hold.
“Remember, as the yield drops, the price of the investment rises” ..isn’t it the opposite way? When price rises, the yield drops. Yield, as you said is a derived value from price and dividend.
Yes, you are correct – but since I was referring to “yield chasers”, the yield drop is a result of the price rise.
I am glad that you mentioned a rising yield could be a sign of trouble or it could be a great buying opportunity. The trick can sometimes be figuring out which.
Good timing here. I’ve got a post that touches on yield on cost coming up at SPF tomorrow. I usually look at the total dividend and ignore the yield. Then I look at the upside potential in the stock.
You’re absolutely right here. IPS is what people should really focus on.
Well, you do care about yield, I think you are saying that a “good yield” on its own is not enough to drive your investment decision. On the other hand, yield is one of the many important factors you look at before you buy/hold a position.
As others have mentioned, yield can be a useful indicator to help you during your analysis. I know that if I found a company with sold fundamentals and good prospects that happens to be trading well below its historical P/E, a higher dividend would be a great sign. For example, Pepsi’s yield is about 3.3%, but its PE is about 16x. I don’t think Pepsi is going away anytime soon and its historical PE is more like 22x+, so I would be happy to collect 3.3% yield while I hold Pepsi for the next 20 years as a “cash cow” holding. (Added bonus, Pepsi has a Beta of .5)
No, I care about the actual dividend amount – not as a percentage of the current stock price. Since PEP is trading below it’s historical PE, you can assume the price will rise in the future – while the dividend may not. So, in actual terms, your yield won’t be 3.3% for 20 years as you hope.
Instead, you will receive $2.06 for each share you own over 20 years. Let’s assume it’s 100 shares today, at today’s close of $65. Today, you would collect $206. That is a 3.2% yield ($206/$6,500 = 3.2%).
Let’s say its price per share then rises next year to $75. You still get $2.06 per share. $206/$7,500 = 2.7% yield. Still not bad, but it will fluctuate over time, and that is why I don’t like it as a metric.
What I really care about as a dividend investor who wants income is that I get $206 per year on my initial investment. It is not the yield that matters, just the income.
The daily yield fluctuates but you still maintain the “yield on cost” from the day you purchase. (If I purchase today at 3% and tomorrow the stock price increases so it yields 2.5%, I still get 3% on that money) The yield matters when you purchase it and should be a factor if you are investing for income as it determines the cost of capital for the dividend received. The yield determines how much it will cost you to get that $2.06 per year dividend. (Will you pay $650 or $750 for the same 100 shares)(Yield helps to determine if one could get a better investment for that extra $100 in another stock)
Once you purchase the stock, you focus on “yield on cost” (If dividends go up, your “Yield on Cost” goes up, if the dividend remains the same then your “Yield on Cost” remains the same).
I always invested in stocks for their value. If i think it’s a good time to buy, then i would invest in it. I never invest for the sake of getting returns in dividends. If the stock I choose to invest happens to offer dividends, then i just consider it as an extra bonus, but would never get too caught up in what the value of it is.
I’m reading this article just after getting my brokerage statement and seeing the yield listed out, so it’s good timing. And clearly something I should give a little more thought to…
Sorry but are you referring to income per share or dividend per share?Two entirely different measures.
I am referring to dividend per share – which is the income I personally receive. Not the company’s income per share.
Thanks for the clarification, but if you pay too much for that income then it’s probably not a good investment. I’d much rather buy a $30 stock with a $1 dividend than a $50 stock with a $1 dividend. Furthermore, the dividend can be fairly arbitrary as two different companies with the same earnings and cash flow, balance sheets, growth etc, can have wildly different dividends.
That’s a great call on why there is some value to yield – but if the companies are very similar, wouldn’t you choose the one with the higher dividend?
If the price was the same yes. Not automatic if not
Makes sense!