Question about Dividends

[why1942]

Hi All,

I was wondering about dividends and if I have this right.

When I buy a stock at $10/Share that pays regular dividends, the dividend yield quoted is the yield-to-date based off of the "current" price, correct? But if I bought the stock to hold long term, and it is a company with a long history of paying a consistent dividend, shouldn't I calculate the actual annual dividend yield based off what I actually paid for it instead of the current stock price?

If, say, the company gradually increases the dividend over time, in essence, doesn't this gradually increase my dividend yield because it is based on the purchase price and not necessarily on whatever the value of the stock is at any given time?

Isn't this the same as buying a bond at face value and who cares if the value of the bond on the open market goes up and down because I'm holding it to maturity to get the income from it. When I sell the bond I get back my initial investment. With stocks, though, I would have to be sensitive to the stock price only when I intend to sell, correct?

Granted, dividends are not a contract agreement like bonds are, but the yields can often be higher and/or they can increase over time unlike bonds. With that potential upside, I know there are many variables and unknowns.

Using the above example stock:

If I bought 1 share at $10/share and the company set the dividend at .25/quarter, this would be a 10% annual return on my actual investment.

If the price fluctuated up and down for that year and the next year it was only worth $9/share, but the company continued to pay the .25/share, my actual ROI would still be 10% because I bought it at $10. If the company decided to raise the dividend to .30/share/quarter, wouldn't my dividend yield go up to 12% ?

Wouldn't this make the current price of the stock irrelevant when holding for the long-term, specifically for the dividend income?

why1942

 

[GrayHare]

When calculating yield I prefer to use the stock's current share price because that allows me to better compare it to other stocks. Otherwise, for example, if a stock you bought at a low price and held long-term is giving you an effective yield of 10%, but is only paying 2% when computed based on its current share price, you might tend to ignore a different stock yielding 4%. However, assuming no tax consequences, switching from your old stock to the different one will double the dividends you collect.

 

[FIREd]

The merit of calculating the yield based on your average cost basis ("yield on cost") has been debated on a number of blogs and forums. Some find it a useful metric while many don't. I tend to fall in that latter category. It's a feel-good metric, but it has little value IMO.

Some articles debating the pros and cons of yield on cost:
Is Yield On Cost Really Important To Dividend Investors? - Seeking Alpha
Dividend Growth Investor: Yield on Cost Matters
Settling The Debate: For Dividend Investors, Yield-On-Cost Matters - Seeking Alpha

 

[RunningBum]

I agree with GrayHare. The market doesn't care what you paid for a stock. You need to look at where it's at now and it's outlook for the future, not how well it's done in the past for you. Otherwise you could be too tempted to hang onto a one-time blue chip stock that is withering, while you could be getting more dividends and a better future outlook on your money with another stock.

 

[CyclingInvestor]

I am retired and living (entirely) off of individual stock dividends.

While I consider long histories of increasing dividends (and earnings) very important in selecting which stocks to follow, the "yield on cost" is irrelevant to me. I would never let my purchase price have any impact on future buy / sell decisions, for the reasons already explained, especially in the referenced "SeekingAlpha" articles.

 

[Texas Proud]

+1 (or even higher) to what all others have said...

As an example.... my mom bought Exxon back in the early 80s... her cost is LOW... so her dividend yield is high by your calculation...

But, if she sold her Exxon, she might be able to get a better yielding stock with better dividend potential... ie, more current income...

Now, she will not because her gain is so high and Exxon is a good stock, but it is not because the yield on her costs...

 

[Danmar]

Totally agree with previous posters. i don't understand why anyone would use yield on cost other than to feel good.

 

[boatfishandnature]

Also agree with the previous posters, with a minor twist:
1) When looking forward, since you plan to holding "for ever" you would want to know the current dividend yield and ignore any potential for appreciation when calculating whether you are getting enough weghted average yield from all your investments to meet your expected return goals
2) If you ever change your mind and want to sell, of course the only thing that matter when comparing the different alternative investments is the yeield on that date
3) When checking your historical returns in the future to see whether you are getting the expected returns, you may see value in doing it both ways - whether the dividends met your expected return on the original investment and what is the total picture including any appreciation/depreciation of the value. However, the second measure is clearly the most important (if you bought Apple stock several years ago betting that it would soon pay dividends, you would have been disappointed on the dividend front , but overall you would have been a very happy camper!!! ).

 

[Ed_The_Gypsy]

Totally agree with previous posters. i don't understand why anyone would use yield on cost other than to feel good.

But I LIKE to feel good!

It is true that the current yield is the way to compare stocks, but selling one to buy another is a taxable event triggering capital gains tax, so there is a bias to keep holding if the basis has gone up over time. Some equities pay good yields but the basis never goes up, which simplifies things. I like the basis AND the dividends to go up.

 

[jerome len]

I buy ETF dividend funds that pay fairly high dividends and increase their dividends each year. Look at I shares HDV, SPDR dividend ETF, SDY or Vanguard Dividend Appreciation, VIG. I really care more about how much money I get, how it will increase over the years than I care about what cost I base my %dividend on.

If you buy a bond the interest you get each year doesn't change. If you buy a dividend fund that has a history of increasing dividends, chances are, over a many year period, dividends will increase at the rate of inflation, allowing you to keep your same life style.

 

[Danmar]

But I LIKE to feel good!

It is true that the current yield is the way to compare stocks, but selling one to buy another is a taxable event triggering capital gains tax, so there is a bias to keep holding if the basis has gone up over time. Some equities pay good yields but the basis never goes up, which simplifies things. I like the basis AND the dividends to go up.

OK I have to admit that I calculate historical yield to get a happy fix but only infrequently. What I am most interested in is the actual amount of dividends received. This is the amount(after tax) that I can spend supporting my lifestyle. A growing stream of dividends is a very good thing because I don't actually need to liquidate any of the portfolio unless it makes sense to rebalance.