 Personal Finance PowerPoint Presentation, Dividend Yield. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia Dividend Yield, which you can find online. Take a look at the references, resources, continue your research from there. This by Jason Fernando, updated August 19, 2021. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investments. That being the fixed income, typically bonds. The equity, typically on the common stock side of things. We're focused here on the common stock side of things as we look at the Dividend Yield. Quick recap, what the common stocks are. Ownership interest in the company. Corporations, separate legal entity that has broken out into the equal shares of the stocks. Representing ownership. We're usually thinking about those investments for publicly traded companies. Those companies that are on the exchanges, giving us more easy access to be investing in them. Remember that the dividends represent the company paying out earnings from the company to the owners. The stockholders, the dividends are similar to draws, say for a partnership or sole proprietor. Where in that case, we would generate revenue. We would be pulling out some of that revenue in the form of a draw as a partner in order to pay off our personal needs. However, corporations, because all the stocks need to be the same in nature, can't have one stock paying more draws out than another stock. It has to be the same uniform. Therefore, the dividends will be determined by the board of directors and the management rather than the owners directly determining what the dividends will be. The dividends are going to be payouts and of course kind of income for us as the owners. Two things that we're looking for as the owners of stock, typically, we're looking for the stock value to grow. In which case the company might take those dividends and reinvest them so that the value of the stock can grow. Or we're looking for payouts of income in the form of dividends as they generate revenue. We would like to get the money so that we can use it for our personal use or invest them elsewhere in the form of dividends. So now we want to think about how we can measure kind of our returns, for example, in our investments on stock, keeping that in mind. What is the dividend yield? The dividend yield expressed as a percentage is a financial ratio, which is just the dividend divided by the price. That shows how much a company pays out in dividends each year related to its stock price. So usually when we say the dividends over price, we're usually considering the dividends on a yearly basis. So we're saying how much dividends are paid out in a year compared to how much the stock price is at that point in time. How much it's selling for on the market. The reciprocal of the dividend yield is the price to dividend ratio price over dividends. Understanding the dividend yield. The dividend yield is an estimate of the dividends only return of a stock investment. Assuming the dividend is not raised or lowered, the yield will rise when the price of the stock falls. So meaning if you look at the ratio, which is of course the dividends. So we just got the dividends that are going to be paid out over the price dividends over the price. So we can see here that assuming the dividends is not raised or lowered, the yield will rise when the price of the stock falls. So if the price, the denominator falls, the dividend yield would rise. We would expect because the dividends are remaining the same on the numerator and the denominator falling. And conversely, it will fall when the price of the stock rises. So the price of the stock goes up and the dividends remain the same dividend yield going to go down. Because dividend yields change relative to the stock price, it can often look usually high for stocks that are falling in value quickly. So new companies that are relatively small, but still growing quickly may pay a lower average dividend than mature companies in the same sector. So notice if the growing company comes into the sector, they might not have the infrastructure yet. Therefore, they might not be paying out the dividends. And that might be okay for certain investors who are looking for the price of the company to go up by them reinvesting the dividends, hopefully investing in assets and equipment so that they can generate more revenue in the future. So in general, mutual companies that aren't growing very quickly pay the highest dividend yield. Consumer non-cyclical stocks that market staple items or utilities are examples of entire sectors that pay the highest average yield. So we might be looking for higher yields when we're thinking about our investment horizon, possibly closer to retirement, when we're focused in on getting the money back because we want to live off of our investments, and we're not opposed to when we're in our working years, possibly when we're trying to invest to save up for retirement, for example. In that case, we might not care so much about the dividend yield, but possibly are more concerned with the growth in value of the company. So although the dividend yield among technology stocks is lower than average, the same general rule that applies to mature companies also applies to the technology sector. For example, as of June 2021, Qualcomm, Incorporated QCOM, an established telecommunications equipment manufacturer, had a trailing 12-month TTM dividend of $2.63, using its current price of $144.41. Since on August 17, 2021, its dividend yield would be 1.82%. Meanwhile, Square, Incorporated SQ, a relatively newer mobile payment processor, pays no dividends at all. That would be because you would think that Square is trying to increase whereas the other company here, which we said was Qualcomm, as already established, has the infrastructure basically in place. They maybe don't need more offices and so on at that point and can therefore give the dividends earnings to the owners as they generate the revenue. In some cases, the dividend yield may not provide that much information about what kind of dividend the company pays. For example, the average dividend yield in the market is very high among real estate investment trusts, REITs, REITs. However, those are the yields from ordinary dividends which are different than qualified dividends in that the former is taxed at a regular income while the latter is taxed as capital gains. So we've got these different tax rates that could apply based on the dividends. I won't dig into that right now. Along with the REITs, master limited partnership MLPs and business development companies, BDCs, typically have very high dividend yields. The structure of these companies is such that the U.S. Treasury requires them to pass on the majority of their income to their shareholders. This is referred to as a, quote, pass-through, end quote process, and it means that the company doesn't have to pay income taxes on the profits that it distributes as dividends. However, the shareholder has to treat the dividend payment as ordinary income and pay taxes on them. Dividends from these types of companies, MLPs and BDCs, do not qualify for capital gains tax treatment, which is typically a favorable tax treatment than ordinary income. While the higher tax liability and dividends from ordinary companies lowers the effective yield the investor has earned even when adjusted for taxes, REITs, MLPs, and BDCs still pay dividends with a higher than average yield. We've got the calculating the dividend yield. The formula for dividend yield is as followed. You got the dividend yield is the annual dividend per year. So notice where we that's key point here because they might be paying dividends annually or some other kind of component. We typically are annualizing things when we're calculating. So that's going to be something to keep in mind annual dividends per year divided by the price per share, which is determined, of course, by the market. So the dividend yield can be calculated from the last full year's financial report. You can find this information from the financial reports to do the calculation. This is acceptable during the first few months after the company has released its annual report. However, the longer it has been since the annual report, the less relevant that data is for investors. So when you look at the annual report, then obviously that data is most relevant when you're close to the annual report. If you're further away into the next or following year, it might not be as relevant to predict future, future happenings and therefore current valuations. Alternatively, investors can also add the last four quarters of dividends, which captures the trailing 12 months of dividend data. Using a trailing dividend number is acceptable, but it can make the yield too high or too low if the dividend has recently been cut or raised. So changes in the dividend when we're trying to kind of like annualize the dividend can have an impact on what we're trying to calculate for the annual dividend amount. So because dividends are paid quarterly, many investors will take the last quarterly dividend, multiply it by four and use the product as the annual dividend for the yield calculation. So we might then say, hey, look, companies usually increase their dividends and don't like to decrease their dividends. So if they've been changing their dividends, you would think going forward, the last dividend payment that they made is what's going to happen going forward. And that's where we're at right now making the decision at the margin. So maybe we should just be calculating it based on the most current dividend and annualizing that in essence. This approach will reflect any recent changes in the dividend, but not all companies pay an even quarterly dividend. So note, oftentimes companies do kind of pay an even amount, but if they don't, then you've got to consider, okay, what's going to be the annual dividend that they're going to be receiving under the current conditions. Some firms, especially outside the US, pay a small quarterly dividend with a large annual dividend. If the dividend calculation is performed after the large dividend distribution, it will give an inflated yield. So finally, some companies pay a dividend more frequently than quarterly. So a monthly dividend could result in a dividend yield calculation that is too low. When deciding how to calculate the dividend yield and investors should look at the history of dividend payments to decide which method will give the most accurate results. Advantages of dividend yields. Historical evidence suggests that a focus on dividends may amplify returns rather than slow them down. For example, according to analysts at Hartford Funds, since 1970, 84% of the total returns from the S&P 500 are from dividends. This assumption is based on the fact that investors are likely to reinvest their dividends back into S&P 500, which then compounds their ability to earn more dividends in the future. In other words, oftentimes when you're invested in the stock market, unless you're living off of the dividends, if you're just owning the stock and you're trying to grow your portfolio, when you receive the dividends, you may have set it up to automatically reinvest in essence the dividends back into the company or into the fund. For example, suppose an investor buys $10,000 worth of stock with a dividend yield of 4% at a rate of $100 per share price. This investor owns 100 shares that will pay a dividend of $4 per share 100 times 4 or $400 total. Assume that the investor uses the $400 in dividends to purchase 4 more shares. So this price would be adjusted on the ex-dividend date by $4 per share to $96 per share. Reinvested would purchase 4.16 shares. Dividend reinvestment programs allow the fractional share purchases. You might say, well, I don't have much money to reinvest, but obviously they're going to set it up in such a way that hopefully you can buy fractional shares to be able to do an automatic reinvestment, which is great for investors that want to basically just let the money ride and roll over. So if nothing else changes, the next year the investor will have 104.16 shares worth $10,416. This amount can be reinvested into more shares once a dividend is declared, thus compounding gains similar to a savings account. Disadvantages of dividend yields. Well, high dividend yields are attractive. It's possible they may be at the expense of the potential growth of the company. So clearly us as investors, we like to have the dividend yield. We like to see the dividends coming back to us, whether we're using it or possibly reinvesting it. But in the growth capacity of the company, the company oftentimes might want to be holding on to the money so they can grow. And so and that's good for us on the investor side of things. If we're trying to get gain, not from getting the dividends, but from the value of the company going up by them purchasing equipment and so on, which hopefully they can get a return on more than we could get if they gave the money to us in a dividend. So it can be assumed that every dollar a company is paying in dividends to its shareholder is a dollar that company is not reinvesting to grow and generate more capital gains. Even without earning any dividends, shareholders have the potential to earn higher returns if the value of their stock increases while they hold it as a result of company growth. It's not recommended that investors evaluate a stock based on its dividend yield alone. So dividend yield is one factor, one component, but not the only component that we're going to use in that component may be more or less valuable depending on our time horizon in particular goals in investing. Dividend data can be old or based on erroneous information. Many companies have a very high yield as their stock is falling. If a company's stock experience is enough of a decline, they may reduce the amount of their dividend or eliminate it altogether. So in other words, if we were to depend just on the dividend yield, we might see falling companies that are looking bad because they're on a decline look better because of the formula of the dividend yield. They're reluctant to cut the dividend that they're paying because that's a bad market signal, even though you've got declines resulting in their stock prices going down. So clearly, that's not the only indicator we would want to use to decide to invest in that particular company because it would give us a false signal that they're looking good. And if we just took on one other piece of data, which is, well, look at their prices trending down, then we would catch that. So investors should exercise caution when evaluating the companies that look distressed and has a higher than average dividend yield. In other words, if you're looking at a company and saying, wow, look at the dividend yield on this company, your next question is going to be what is going on here? Is that because their prices declining sharply and they don't want to cut their dividends because that would look bad? Because the stock's price is the denominator of the dividend yield equation, a strong downtrend can increase the potent of the calculation dramatically. So for example, General Electric Company GE Manufacturing and Energy Division began underperforming from 2015 through 2018 and the stock price fell as earnings declined. The dividend yield jumped from 3% to more than 5% as the price dropped. As you can see in the following chart that declined in the share price and eventual cut to the dividend offset any benefits of the high dividend yield. And here's the chart so you can check that out. Dividend yield versus dividend payout ratio, when comparing measures of corporate dividend, it's important to note that the dividend yield tells you what the simple rate of return is in the form of cash dividends to shareholders. However, the dividend payout ratio represents how much of a company's net earnings are paid out as dividends. So note when you're looking and trying to value the company, the dividends are one form of earnings that you're getting from the company. The other form of earnings could possibly be the growth and the value of the shares, for example. While the dividend yield is the more commonly used term, many believe the dividend payout ratio is a better indicator of the company's ability to distribute dividends consistently in the future. The dividend payout ratio is highly connected to a company's cash flow. So when we're looking here, we're looking more on the cash flow component. The dividend yield shows how much a company has paid out in dividends over the course of a year. And the yield is presented as a percentage, not as an actual dollar amount. This makes it easier to see how much return the shareholder can expect to receive per dollar they have invested. Example of dividend yield. Suppose company AU stock is trading at $20 and pays annual dividend of $1 per share to its shareholders. Suppose the company B stock is trading at $40 and also pays an annual dividend of $1 per share. So this means company A's dividend yield is 5% $1 divided by $20. While dividend B's dividend yield is only 2.5% because they got that same $1 dividend divided by the share price, which is $40. Assuming all other factors are equivalent and investors are looking to use their portfolio as to supplement their income, would likely prefer company A over company B because it has double the dividend yield. So if I was to invest in company A and purchase the stock at $20, we're getting a higher yield compared to the price that is being paid versus the $40. But that's not, of course, the only factor you want to consider when you're making your investment decisions. What does the dividend yield tell you? The dividend yield is a financial ratio that tells you the percentage of a company's share price that it pays out in dividends each year. For example, if a company has a $20 share price and pays a dividend of $1 per share, its dividend yield would be 5%. If a company's dividend yield has been steadily increasing, this could be because they are increasing their dividend because their share price is declining, or both. Depending on the circumstances, this may be seen as either a positive or negative sign by investors. Is a high dividend yield good? Yield-oriented investors will generally look for companies that offer high dividend yields, but it is important to dig deeper in order to understand the circumstances leading to the high yield. One approach taken by investors is to focus on companies that have a long track record of maintaining or raising their dividends, while also verifying that those companies have the underlying financial strength to continue paying dividends well into the future. To do so, investors can refer to other metrics such as the current ratio and the dividend payout ratio. So why is dividend yield important? Some investors, such as retirees, are highly reliant on dividends for their income because now they're past their earnings years. They want to live off of their investments. They want the income from the investments in the form of dividends and possibly bonds with interest. So for these investors, the dividend yield of their portfolio could have a meaningful effect on their personal finances, making it very important for these investors to select dividend paying companies with long track records and clear financial strength. For other investors, dividend yield may be less significant, such as for younger investors who are more interested in growth companies that can retain their earnings and use them to finance their growth.