Page 148 - CalcBus_Flipbook

18-12 Securities: Stocks & Bonds CH 18]

Example: Presume that Microsoft pays an annual dividend of $1.53, and the stock trade
value was $52 when purchased. Calculate Microsoft’s dividend yield.

Solution algorithm:
Dividend yield = Annual Dividend x 100%
Stock Trade Value Price

Dividend yield = $1.53 x 100% = 2.94%
$52.00

It is important to note that a stock’s dividend yield does change over time, up and down, in
response to market fluctuations. The average stock trade value price the investor pays for all of his
stock in a company, and the dividend increases or decreases by the issuing company.
The Dividend yield then is the annual income (dividends) the investor receives expressed as a
percent of an investment. In the discussion above the rate of yield is 2.94%. This would also be the
return on the investment for the investor.

Total return
Dividends, being paid on the Par value of the stock make up only one component of a stock’s
total return. The other is the change in the price of the stock when it is sold. To illustrate, if a
stock’s price increases by 7% this year and it pays a 3% dividend, then the total return is (7% +
3% =) 10%; this is assuming that the stock is sold.
When investing for the long term the stock’s total return potential in addition to the yield is
considered:
Total return % = Dividend yield % + Price Change %

Considerations: When shopping for dividend stocks, it's important to keep in mind that a high
dividend yield alone doesn't make a stock a great investment. There are several things to consider
before purchasing which include, though are not limited to:

 Does the company have a strong history of profit growth and dividend increases? There is a long
list of companies, known as the Dividend Aristocrats, that have all increased their dividends for at
least 25 consecutive years – this may be a good place to start.
 Is the company's financial position strong? Namely, does the company have a reasonably low debt
load and an investment-grade credit rating? Reviewing the Company’s balance sheet explains it
financial position.
 Is the dividend sustainable, or is the company paying out too much of its profits as dividends? Be
certain to consider the "payout ratio," which is the percentage of profits that a company spends on
dividends. As a rule look to companies that pay out under 50% of earnings as dividends and
retains the balance as retained earnings which are used for growth and to cover operating
expenses.
 Does the company have potential to grow over time? Often people think that the increases in
market, stock prices and dividends will always increase. History disproves this and the investor
should be mindful of this point. Utilities and telecom stocks tend to pay out high dividends, but
they have limited growth opportunities. It is important to create an income stream through
investments that will grow. This also means that from time to time poor performing investments
will need to be sold off and new investments purchased.

Example: Jane Heathrow purchased stock at $97 a share including commission. During the
past year, she received quarterly dividends of $1.75 per share. She then sold this
stock receiving net proceeds of $112 per share. What is her rate of yield (a) for the
dividend and (b) for the total investment upon sale? Round to the nearest
hundredth.

Solution algorithm:
(a) $1.75 x 4 = $7.00 annual dividends per share

$7.00
——- x 100% = 0.0722 x 100% = 7.22% rate of yield
$97

(b) (Sale Value — Purchase Value)
———————————————- x 100% = rate of yield % (Price Change %)
Purchase Value

($112 — $97)
—————— x 100% =
$97
Copyrighted Material