If we are going to talk about dividend stocks we need a way to compare dividends.
A dividend is an amount paid to shareholders of a company stock as a return of shareholder capital. Dividends are a sign of a healthy company since the only way for a company to pay out cash is to actually have cash. There is no way to hide a cash payment in a company’s account. This cash payment is part of an individual investor’s overall return.
What Is Yield?
The yield is simply the return provided by an investment. An investment of $1,000 that returns $100 to you provided a yield of $100.
But, there are some important variables that need to be understood in order to compare yields.
Check out this Zelle review.
For example, compare two $1,000 investments. One investment returns $100 in one month. The second investment returns $100 in ten years. Obviously, the first investment is far superior to the second investment. Over the same period of time, the first investment would return $12,000 versus just $100, assuming no reinvestment.
Any real comparison of dividends requires that we take time into consideration.
What Is Dividend Yield?
The dividend yield is the yield is the amount of cash a dividend stock investment pays to a shareholder over a 12-month period relative to the stock price. The actual formula for dividend yield is:
Dividend Yield = annual dividends per share + price per share
There are a few different ways to calculate the annual dividends per share.
Assuming the company’s dividend does not change, then the simplest method is to add simply take the dividends paid during the last year and add them up to be the annual dividends per share.
However, if the company raises or lowers the dividend during the year, then that will not reflect the amount the investor can expect to earn on a new investment in the company’s shares.
Companies announce changes to their dividends in advance. Thus, an investor could calculate dividend yield by looking at the expected dividend payments for the next 12-months, and add them up to calculate the annual dividends per share. However, if the company does cut its dividend during the year, then the investor will earn less than expected based on the dividend yield calculated.
The most common way, then to calculate a company’s yield is to take its most recent dividend yield payment and extrapolate it across the year. For most publicly traded stocks this is done by simply taking the last quarterly dividend payment and multiplying by 12.
An investor should always research and understand all recent dividend changes and any announced upcoming changes to the company’s dividend before investing.
As a stock’s price changes, its dividend yield changes, even when the dividend itself does not change.
Just like with bonds, or other interest-bearing securities, the yield is inversely proportional to the price. In other words, yield and price move in opposite directions. When the price of a stock rises, its dividend yield decreases. When the price of a dividend stock decreases, its dividend yield increases.
The most important thing to understand as an investor when it comes to dividends is that your dividend yield DOES NOT CHANGE while you own the stock unless the company changes the amount of the dividend.
Again, unless the company changes the amount of the dividend paid, your yield stays the same for as long as you own the stock.
Here is why that matters.
These Credit Karma reviews are useful.
Let’s say we buy shares of Pfizer stock at $38.64 with a dividend yield of 4.05%. If the price of Pfizer stock rises, then the dividend yield for the stock falls because it costs more money per share to earn $1.56 worth of dividends. Likewise, as the price falls, the dividend yield rises, but since we already paid $38.64 per share the only thing that can change our yield is how much the company pays.
The reason this is so important for long-term dividend investors is that as the price rises, there is no reason to sell the stock to find a higher yield. In fact, the best-case scenario for us is that Pfizer stock doubles in price and our original investment also doubles in value, but we keep earning over 4% on our investment while new investors only earn approximately 2% (assuming no change in dividend payouts made by the company). In this way, we can earn money on our investment without having to sell it.
Likewise, if Pfizer stock were to drop 50% in price, we would still earn 4% on our investment. Assuming we have no need to sell and take a loss we can simply continue to enjoy our 4% return while the stock price languishes. This is the most important thing to understand about dividend investing. Even though the balance of our portfolio will show us being “down” on our stock price purchase, we are under no obligation to sell. And, unless the company cuts the dividend, we will continue to earn that 4% regardless of price, even if the stock price remains lower for years.
Put another way, because this is the key to dividend investing, we can only lose money on our investment when we sell. If we don’t sell, we can only profit. The only way to force us to sell is for the company to go bankrupt.
Short of bankruptcy, our only concern is if the company cuts the dividend. In that case, our dividend yield will fall. Again, our profitability continues to be guaranteed under any circumstance where the company does not declare bankruptcy, and we do not sell our stock.
What Is TTM Yield?
As we said there are different ways to calculate dividend yield depending upon how you calculate the yield. The TTM Yield is one way to calculate yield.
TTM stands for Trailing Twelve Month Yield. To calculate the TTM Yield, you add up all of the cash dividend payouts for the previous 12 months and consider that to be the yield. Then you divide by the share price as above.
Unless the dividend changes during the year, the TTM and the dividend yield should be very similar.
Acorns investing is another way to get fractional shares and dividends.
Some brokerages are now allowing investors to purchase fractional shares in companies. It is important to understand whether you will be paid dividends on fractional shares.
As far as Pfizer is concerned, you either own a share of Pfizer stock, or you do not. The company pays the dividend to shareholders of record on the record date. There can only be one shareholder of record per share of stock.
When it comes to fractional shares your broker uses internal accounting to keep track of any fractional shares you own. For example, if you own one-half share of XYZ stock, the brokerage must purchase one whole share of XYZ stock. If another investor with the company also owns a half share, the company’s computers will simply keep track that half is yours and half is theirs. Assuming the company pays you dividends for fractional shares, when XYZ stock pays a $1 dividend, it will pay one full dividend to the broker-dealer who actually owns the whole share. The broker will then credit your account $.50 and the other investor’s account $.50.
It may be possible for a brokerage to not pay dividends on fractional shares, so be sure to compare micro-brokerages that allow fractional shares, as well as other full-size brokers offering fractional shares to fully understand what happens with your dividends. For example, popular mini-broker Stash does pay fractional dividends to its fractional dividend shareholders, as does Fidelity’s Stock by the Slice program.
About the Author – Brian Nelson
By Brian Nelson – Brian is a former Certified Financial Planner and financial advisor. He writes for the Finance Gourmet and other financial publications. The material provided on this website is for informational use only. Brian Nelson does not provide tax, investment, or financial services and advice. The above is not intended for financial or investment advice. At the time of publication, Mr. Nelson owned shares of Pfizer stock, however, that may change at any time without notice. ArcticLlama, LLC, FinanceGourmet.com, and Brian Nelson, assume no liability for any loss or damage resulting from one’s reliance on the material provided. Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional when making decisions regarding your financial or investment options.