dividends paid over time

Dividend Growth or Dividend Yield? Growing Passive Income in the Stock Market

Erik Financial Education, Markets, Thoughts of a Mastermind 7 Comments

This is a guest post by Buy, Hold Long. Buy, Hold Long is a blog where smaller and sometimes unusual dividend growth companies are analyzed. His blog was created in late 2016 and shares insights into different investing methods and the story of the author’s net worth over time. Check out Buy, Hold Long and say G’day!

Dividend Definitions

There are a number of publicly listed companies provide what is known as a dividend– a cash payment for being a shareholder of the company. Shares of a company can be bought and sold in different markets. Many people will focus on the appreciation of equities over time, but not today. Rather, we will focus on the dividends paid per year.

Many large companies past the growth stage will pay a dividend. They pay dividends because they don’t necessarily want to put their cash to work in new markets or products and would rather increase shareholder value.

When a company decides to pay a dividend at a certain time, they will nominate how much the dividend will be and when the payment will occur. The holders of these shares will receive that dividend in either a cash payment or in more shares, through a Dividend Reinvestment Plan (commonly known as DRP or DRIP). Most dividends are pay out on a quarterly basis.

Essentially, if you own shares in a company and the company issues dividends, you will receive a portion of profit from the company in the form of cash payments.

Now on to the analysis of dividend yield and dividend growth to determine which is best for long term investing.

Dividend Yield

Dividend yield can be considered as a stocks dividend payment divided by the stocks price. For example, if a company has a current stock price of $100 and pays you a yearly dividend of $2.25 per share, then the dividend yield is 2.25%. Note, dividend yield is a annual rate. As mentioned above, most dividends are paid out quarterly, so care will have to be taken when going from quarterly to annual. This is a simple calculation.  Below is the formula to use to calculate dividend yield:

Let’s do a real life example.  I want to analyze McDonald’s Corp Stock (MCD) to get their dividend yield. We know their last dividend payment per stock owned was $0.94 per quarter. To get the annual dividend payment, multiply $0.94 by 4. The current stock price as of today (March 27th, 2017) is $129.34.

Therefore, our calculation would be:

McDonald’s stock as pays us back 2.907% per year just for owning this stock. One thing that should be noted is that both the stock price and dividend can fluctuate. Not all companies increase their dividends and not all stock prices will go up.

Dividend Pop Quiz

Let’s take a pop quiz, the share price of McDonald’s falls to $115 per share from the current $129.34 per share, but the company decides to keep the current dividend of $0.94 per quarter per share. Does your dividend yield go up or down?

That’s right, it increases. As the price goes down and the dividend payment remains or increases, your yield goes up.

Comparing Companies

The next natural question is what is a good dividend yield? Is 2.907% good or bad for dividend yield? Let’s look at another company to compare. We already looked at McDonald’s (MCD); now let’s analyze Mattel Inc (MAT). Both are well known, respected companies in their field that pay dividends.
McDonald’s, as we have discovered, pay out a dividend yield of 2.907% per share owned. Currently, Mattel pays a dividend of $0.38 per quarter per share and their current share price is $25.16. Uusing the formula from above, we get a dividend yield currently of 6.04%.

So in reality, you would be getting double the cash payments from Mattel through dividends than you would be getting back from McDonald’s, right? While that statement is fundamentally true, the logic is flawed.

It’s important take into consideration dividend growth and the possibilities that they can create in themselves. Also, just because the company is paying a higher dividend, this doesn’t necessarily mean they are more financially sound than companies paying a lower dividend. The money could be borrowed, from a previous year’s cash holding or a company effort to attract more investors.

Let’s dive into dividend growth and see how it affects the analysis.

Dividend Growth

Dividend growth is the concept of a stock that pays a dividend that will continue to grow over time. When a company increases their dividend over time, with dividend growth, it increases your original dividend yield.

Let’s go back to the two companies we looked at earlier, McDonald’s (MCD) and Mattel (MAT). I’ve plotted the annual dividend payments over the past 17 years to show the dividend growth. The blue columns are MCD dividends and the red columns are MAT dividends.

dividends paid over timeIn the year 2000, Mattel had a higher dividend payment and yield than that of McDonald’s. In 2003, the two companies had the same dividend payment. Now, we must remember that the prices of the two companies are vastly different, so while Mattel’s dividend was the same as McDonald’s dividend, Mattel’s yield was a lot higher as the price was lower.

As you can see, over time, Mattel’s dividend has fluctuated drastically.  This volatility leads to uncertainty for the shareholder. To add to that point, if you bought the stock in 2000 at a great dividend paying year, you would have been severely disappointed in the following couple years. Mattel cut their dividend in 2001 and 2002!

McDonald’s has continued to grow for many years since the 2000’s. Currently, the dividend yield might be a little low compared to other companies, but it’s growing each and every year.

What if You Had Bought in 2000?

Consider the following: what would your dividend yield today be if you bought in 2000? As I stated, if you bought MCD today you would have a 2.907% dividend yield and if you bought MAT today, you would have a 6.04% dividend yield.

Back to the question, if you bought in 2000, your dividend yield would be 28.5% dividend yield for MCD and only a 11.20% dividend yield for MAT. The conclusion is obvious, dividend growth is a powerful tool to harness in your investment portfolio!

Conclusion

As you can see from this analysis, dividend growth beats dividend yield when you are looking to invest for many years. I am a buy and hold for a very long time type of investor – this style fits my personality greatly.

Even if a stock has a relatively low yield, if there is potential for dividend growth, the potential will outweigh the temporary low yield. This is why so many investors favor low dividend yields with high growth over a volatile high yield with low growth.

Thanks for writing Buy, Hold Long! Buy, Hold Long is a blog where smaller and sometimes unusual dividend growth companies are analyzed. His blog was created in late 2016 and shares insights into different investing methods and the story of the author’s net worth over time. Check out Buy, Hold Long and say G’day!

Comments 7

  1. Thanks for having me Erik. If you like this style of analytics then be sure to check my site out. I also have a guest post from Erik recently which I think many would find very interesting. Thanks for having me!

  2. I have recently done quite a bit a rebalancing in my portfolio and all my new purchases were companies that have been increasing their dividends. I am currently trying to balance between the current yield and the future growth potential. If a company has both, I will be more that happy to add it to my portfolio.

    Your analysis is very thorough and the examples are simple and straightforward. I think that a lot of new dividend investors will appreciate the effort that you put in to educate others.

  3. I definitely agree that dividend growth is a powerful factor. I definitely like looking at companies that are Dividend Aristocrats!! Definitely makes me feel a little bit better about my investments 😉

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