What is dividend yield?
Dividend yield is the dividend you earn from owning a companies stock expressed as a percentage of a current share price. Dividends are a regularly-issued taste of a company’s corporate profits paid on a per-share basis regardless of whether a stock happens to be up or down, though boards of directors may raise or lower them depending on the financial health of the company. Dividends, by and large, are more common with older, massive companies. Procter & Gamble pays them; Google does not.
Since dividends are paid to investors on a per share basis, it doesn’t make a whole lot of sense to compare actual dividends to assess whether a company pays a lot back to investors. For example, Ford Motor Company pays a dividend of around 15 cents per share while Apple pays around 73 cents. So, it would seem like you’d make a lot more in dividends from Apple, right? But consider this: Ford stock’s been trading at around $10 per share while Apple’s stock trades at over $150 per share so a $150 investment in Apple would get you 73 cents in quarterly dividends but the same dollar amount in Ford stock would net you 208% more — $2.25.
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Dividend yield is a way to make an apples-to-apples comparison of dividends from one stock to another based upon how much the dividend represents as a portion of a stock price. Dividend yield is computed by diving the amount a company pays per year by the share price, so for example, if XYZ Corporation pays a $10.00 annual dividend on a $200.00 stock, the dividend yield would be 5%.
Dividend yield formula
Without further ado, presenting the ultra-rare financial equation that — it’s pretty simple:
Dividend yield = Annual Dividend/Share Price X 100
Dividend yield is always expressed as a percentage. As with anywhere else, the financial world is rife with people who argue whether you dip your grilled cheese in toe-may-toe or toe-mah-toe soup! You could encounter a dividend yield that reflects the total dividends paid during the most recent fiscal year, total dividend paid over the past four quarters regardless of the year, or even the most recent dividend multiplied by four to extrapolate future dividends. This can make a big difference if a particular stock has experienced any large price swings. As you can see by fiddling with a chart like this one showing Exxon’s historical stock price as it related to the stock’s dividend yield, when the stock price goes up, the dividend yield will go down as the dividend represents a smaller percentage of the stock price, and vice versa, how a lowering stock price generally means a higher dividend yield.
For this reason, a stock owner may not be in the mood to celebrate a rising dividend yield. In 2018, Ford had a super high dividend yield of almost 7%, but this reflected by the fact that the stock had lost nearly 50% of its value in the prior 5 years. There’s even a term for companies that use high dividend yields to lure investors into buying dud stocks: dividend value traps. And you’ll probably want to avoid those!
How to calculate dividend yield
Dividend yields will vary depending on which numbers you use to plug into the equation. By far, dividend yield is used most commonly to refer to current dividend yield. This requires one more step than the above equation, since you’ll be multiplying the current quarterly dividend to reflect how much the annual dividend should be (provided the dividend is neither increased nor decreased.)
Current dividend yield = (Current dividend X 4)/(Current share price) X 100
So for example, here’s the dividend yield for AT&T for January 2, 2019.
The stock closed at $29.54. The quarterly dividend was .50
AT&T dividend yield as of 2 January 2019 = (.50 X 4)/$29.54 X 100, or 6.77%
Now let’s compute a historical dividend yield for Microsoft, using October 27, 2004, the day that in winning the World Series, the Boston Red Sox finally broke the 86 year-long Curse of the Bambino. The stock closed at $28.15. The quarterly dividend was .08. So:
On that day, Microsoft’s dividend yield was (.08 X 4)/$28.15 X 100, or 1.137%
Dividend Reinvestment Plans
Pity the poor Dividend Reinvestment Plan, saddled with the DRIP, possibly history’s worst-ever acronym. It’s a shame, because DRIPs are singularly un-drippy, an amazing key to wealth creation whose power couldn’t be any easier to harness. See, when you invest in a company that pays dividends or in mutual funds or ETFs that invests in those companies you will have the option of either receiving quarterly dividend payments or instead reinvesting them through a DRIP. A DRIP simply takes those dividends and purchases more of that dividend yielding company’s stock, without transaction or trading fees. You don’t have to look out for specific stocks that offer DRIP programs, some robo-advisors will reinvest your dividends for you. This means you can keep to your investing strategy and be investing more money (your dividends) without even thinking about it.
Even if Albert Einstein didn’t actually call compound interest the “eighth wonder of the world” as legend has it doesn’t lessen the phenomenon of how gains on gains miraculously create a snowballing effect for investment value. A rising stock price is one engine of this growth and consistent dividend reinvestment the other. Dividend fan sites (yep, there’s a slew of ‘em) love to point out that a good chunk of Warren Buffett’s $80 billion net worth can be attributed to the fact that his biggest holdings are in companies like Wells Fargo, Kraft Heinz and Coca-Cola, all of which pay dividends. Even if one of the stocks you want to invest in doesn’t have a DRIP program some investment providers will automatically invest dividends for you.
Funding your retirement with dividends
It’s up to you what you want to do with your dividends. You could reinvest them, spend them or keep them for later in life. Those who have read any retirement primers like this one will surely have heard of the 4% rule, a guideline introduced by a financial advisor named William Bengen. Mr Bengen ran the numbers and figured out that if you withdraw 4% of a well-invested retirement portfolio annually and adjust for inflation, you are less likely to run out of money in your retirement. If you have a balanced, diversified portfolio, the growth of the stock market (which has historically grown by about 7% annually) would make a 4% annual draw down on funds reasonable without ever having to touch your principle. Be warned though: investments are speculative and it’s important to understand that past results should never be understood to be guarantees, but rather imperfect predictors of future performance.
One particular retirement investment strategy that hopes to achieve a consistent income is investing in stocks that pay dividends year in and year. This means that regardless of any given stock’s performance you’ll have a consistent stream of annual income. That said, if when some companies perform poorly they pull back on the dividends they pay out and reinvest that money in the company. Of course, as we talked about above, dividend yield may go up and down depending on the stock price, but a consistent holding of a company’s shares will make sure the dividend stays about the same. In fact, there’s a list of stocks referred to as the Dividend Aristocrats, the 53 stocks in the S&P 500 that have increased their dividends every one of the last 25 years, demonstrating that even in the absolute worst market conditions, they value their investors and attempt to retain them with escalating cash payouts — they’re a little like the tips you may pay your apartment building doorman or UPS guy to assure your Amazon boxes arrive at your door without looking like they’ve been dingoes’ chew toys.
But be warned: regardless of their dividends, stock picking is never, ever a good idea; tons of studies show that even professionals paid to pick stocks fail to outperform the market as a whole over the long term. For this reason, many of the greatest investing minds in history like the father of Modern Portfolio Theory Harry Markowitzadvise that a highly diversified portfolio maximizes investment upside and minimizes potential downside over the long term. Ford Motor Company may have a great track record of paying dividends but if your $100,000 investment went down in value by 50% in the span of just a few years, those annual checks might provide cold comfort?
If you embrace the principle of investment diversification but also want to try to pay bills with dividends, there are great options. Since companies that pay dividends are often the old financial behemoths that have been around forever, an investment in a low-fee ETF that specializes in large-cap stocks will provide a relatively high per share dividend yield on your investment. There is also a handful of ETFs like this one from Vanguard which tracks the FTSE High Dividend Yield Index, investing exclusively in corporations with high dividend yields. Since one price will buy you slivers of almost 400 companies, you’ll hopefully be cushioned from ugly downturns in specific companies or sectors while still being able that quarterly dividend check to keep the lights on, your fridge full and the kitty fed during your retirement. To further diversify your portfolio you could sign up with a robo-advisor who’ll invest your money across a plater of stocks, bonds and real estate in multiple markets and industries.
Nobody appreciates the compounding power of DRIPs more than Wealthsimple does. When you invest with us we’ll provide you with a diversified, low-cost portfolio. Why not start investing with Wealthsimple today? We offer state of the art technology, low fees and the kind of personalized, friendly service you might have not thought imaginable from an automated investing service — get started now.