Why Poorly Performing Stocks Often Offer the Highest Dividend Yield
Understanding dividend yield can be a little puzzling, especially when it comes to poorly performing stocks. Let's break down why these stocks often provide the highest dividend yields.
The Basics of Dividend Yield
Dividend yield is calculated by dividing the annual dividend per share by the current stock price. This simple math can sometimes lead to misleading interpretations, especially in volatile market conditions. For example, let's take two hypothetical companies, Company ABC and Company XYZ, each trading at $100 and declaring a $4 dividend per share. Here's what happens over the next 30 days:
Company ABC:
Announces great news and the stock price doubles to $200. The dividend yield drops to 2% ($4 / $200). Your account value doubles, but the yield decreases.Company XYZ:
Announces bad news, and the stock price drops to $50. The dividend yield increases to 8% ($4 / $50). Your yield increases, reflecting the improved yield despite the price drop.As you can see, the change in yield is due to the change in stock price—not the dividend amount—demonstrating the inconsistency in traditional dividend yield measurements.
Regular Updates: The Good News All the Time
I often publish an 'all-good-news' investment newsletter, where the market's performance either way is viewed through a positive lens:
When the market goes up:
I might say: 'GOOD NEWS!!! STOCKS UP TODAY EVERYONE'S ACCOUNTS ARE UP'When the market goes down:
I might say: 'GOOD NEWS!!! DIVIDEND YIELDS ARE UP TODAY!'This perspective highlights how dividend yields can provide a buffer during market downturns, essential information for investors to consider when assessing the true value of their portfolio.
Price Charts and Dividend Yields
Looking at the price chart of high dividend stocks can be misleading. The stock price doesn't move as much because investors are receiving a fixed percentage of the company's profits as dividends. Take for instance a stock paying a $4 dividend and selling for $10. Over 10 years, the stock price could rise to $12, making it appear poor. However, if we factor in the $40 in dividends received, it's more accurate to say the stock went from $10 to $16. And when compounded, this could be closer to $18.
Company Strategies and Dividend Yields
Companies can choose to reinvest profits back into the business or distribute dividends. Growth-oriented companies with high growth potential often plough back profits into the business, leading to greater share price appreciation. Thus, these companies typically have lower or no dividend payouts.
On the other hand, mature companies with more stable business cycles and flattened growth often need to distribute a significant portion of their profits as dividends. They might reinvest part of the profits into diversification or other ventures. This strategy is reflected in the dividend yield, which may appear higher because the stock price remains relatively stable, and dividends provide regular income to shareholders.
Conclusion
The highest dividend yield often reflects the price stability of mature companies, providing a better return through regular dividends compared to high share price volatility. Understanding the nuances of dividend yields is crucial for making informed investment decisions, especially in a landscape where market performance is unpredictable.