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?