Dividend yield
BUY AND HOLD YIELD INVESTMENTS STRATEGY
Reduced share prices offer opportunities to investors seeking income through
dividends
when buying into the market. They may receive increased dividend yields which
equate
well to other forms of investment income options.
The dividend yield is a way of comparing the dividend you receive versus the
current market
“value” of a share - “What percentage of the current market price am I getting
back when I
receive a dividend payment?”
It is also a way of comparing the income from shares directly to the income
from interest
rates available on bank accounts and deposits.
[Formula:
dividend yield = (dividend per share / market price) x 100%]
Company: “ABC”
 |
| Dividend per share |
= $0.30 |
| Current market price |
= $2.00 |
| Dividend yield |
= ($0.30 / $2.00) x 100% |
|
= 15% |
| Initial Investment Value |
= 5,000 ABC shares @ $2.00 each |
|
= $10,000 worth of ABC shares |
| Dividend yield |
= 15% |
| Expected return on $10,000 |
= $1,500 |
|
It is important to note that the dividend yield is affected by the daily
changes in the market price of ABC shares
and the future earnings potential of the company, therefore the expected return
can fluctuate from day to day.
Calculating a dividend yield
Refer to the fictional scenario below:
Formula: dividend yield = (dividend per share / market price) x 100%
|
| DAY 1 |
| If the market price of ABC shares is $2.00 per share and the dividend per share
is always constant at
$0.30, then the dividend yield is 15% |
| Formula: $0.30 / $2.00 x 100% = 15% |
| On Day 1, the (potential) return on your initial investment of $10,000 is
$1,500. |
| If a purchase is made at $2.00 on DAY 1, the
dividend yield is "locked in" at 15% and will
not alter unless the dividend amount ($0.30)
changes. |
| DAY 2 |
| If the market price of ABC shares is $2.20 and the dividend per share is $0.30,
then the dividend yield is adjusted to reflect the change in the market price
and
becomes 13.6%. |
| Formula: $0.30 / $2.20 x 100% = 13.6% |
| On Day 2, the (potential) return on your initial investment of $10,000 is
$1,360. |
| If a purchase is made at $2.20 on DAY 2, the
dividend yield is "locked in" at 13.6% and will
not alter unless the dividend amount ($0.30)
changes. |
| DAY 3 |
| If the market price of ABC shares lowers to $1.90 and the dividend per share is
still $0.30, the
dividend yield is adjusted to reflect the change in the market price and
becomes 15.8% |
| Formula: $0.30 / $1.90 x 100% = 15.8% |
| On Day 3, the (potential) return on your initial investment of $10,000 rises to
$1,580. |
| If a purchase is made at $1.90 on DAY 3, the
dividend yield is "locked in" at 15.8% and will
not alter unless the dividend amount ($0.30)
changes. |
|
The effect of the current market price on the dividend yield
The reason that a low share price creates a high dividend yield (and vice
versa) is due to the
fact that the dividend per share is dictated by the company’s level and
distribution of earnings
to shareholders, regardless of how high or low the market price of the share
is.
If the market price of ABC shares doubles due to positive developments within
the company, the dividend
remains the same and therefore the percentage paid out to shareholders in the
form of dividend payments,
based on the doubled share price, is comparatively lower.
If you
purchased when the share price was $2.00 per share, a $0.30 dividend is 15% of
the value of 1 ABC share. If the share price
suddenly doubled and you purchased at $4.00 per share, a $0.30
dividend is 7.5% of the value of 1 ABC share.
So even though the share price of ABC has doubled and the company is obviously
“doing well”, the dividend
per share is not adjusted to reflect the newfound success of the company. In
comparison to the “value” of
a share in ABC ($4.00), the dividend paid per share ($0.30) is a relatively low
percentage of the market
value, at only 7.5%.
If ABC’s share
price hit troubled waters and the share price fell and you purchased at $3.50,
a $0.30 dividend is now a
greater percentage of the market value – 8.6%.
Other options
If the on
market price of your shares is lower than your initial
purchase price, you can still earn money through your dividends because the
dividend yield is higher. If the dividend yield
is low due to the on market price being higher than your initial purchase
price, you can still
earn money by selling your shares on market because the price per share is
higher than your initial purchase price.
Forecasting dividends
The dividend paid by the company to distribute profits to shareholders may be
hard to forecast. Companies
offer guidance on what the earnings and dividends might be throughout the year.
These are announced through
the stock exchange (like
this seen here)
or may be available in the investor centre on the company’s website. Larger,
more stable and dominant companies
with inflexible demand tend to offer similar dividends from year to year, even
during tough economic periods.
Investing with a bank
Interestingly, the return on a $10,000 deposit in a savings account or a term
deposit at a bank doesn’t always
measure up to the (potential) return available to an investor who owns ABC
shares.
Refer to the fictional scenario below:
|
Initial investment value |
= $10,000 |
| |
Interest rate |
= 4.00% p.a. |
| |
Expected return on $10,000 |
= $400 (assumes interest paid at maturity) |
Even if interest rates rose to 6.00%, the expected return ($600) is still less
than what a 6.7%
dividend yield would provide ($670).
Of course the risks involved in share trading greatly outweigh the risks you
face when investing
your money with a bank, so it pays to consider if you would be prepared to
choose a higher but riskier
(potential) return, or if you would prefer to opt for a lower but safer
(potential) return. You must
decide whether the premium on the potential income offered is worth the
investment, as opposed to putting
the money in the bank where the interest rates being offered only just beat
inflation.
Online resources
We recommend that you obtain as much data as possible to make an informed
decision before you place an order to purchase shares.
Quick Quote – View: News
Use this menu to view announcements from the company in regards to their
earnings and profit reports. Refer specifically to
annual/half yearly reports – this is where you’ll find figures relating to
profit/loss, revenue, and the up-coming dividend amount.
Quick Quote - View: Detailed
Use this menu to view company specific details, including the Total Issue of
shares in the market, Market Capitalisation,
Earnings/Share, Price/Earnings Ratio, Dividend/Share and Dividend Yield.
>> Quick Quote tutorial for
additional guidance
Interest rates
You can view interest rates offered by financial institutions in New Zealand at
interest.co.nz. You
can also view the interest rate offered
by the Direct Broking Call Account (PIE) here.
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