Dividend Yield

The last parameter used is the dividend yield. In theory, the stock or company is the asset and the dividend is the income stream. In perfect tax conditions, companies should return the profits to shareholders in form of dividends, and withhold cash only for investments to grow the company. Taxation makes this more difficult. I will not discuss this topic here, however a company with healthy dividends shows, that the company is actual profitable, not just on paper, it has shareholders interest in mind, and it is willing to distribute profits to shareholders, instead of spending it on executive bonuses.

Common sense dictates that the higher the dividend yield, the higher returns can we expect.

But is this true? In theory, it does not count, if a company has huge dividends or none. There are companies like Amazon, who never had any dividends, or even made any profits, and still their investors had huge returns. There are many ways how a company can return value to its investors. It can have dividends, but it can use the same money, to grow, to buy other companies, or to buy back shares.

Based on the correlation common sense in this case wins over theory. There is a strong correlation between the dividend yield and the returns that we can expect at least in the case of the S&P500 index.

If a company has high dividend yield it means that is willing to return the generated money to the investors.

The media is full with high value acquisitions, and in most cases these expensive acquisitions do not pay off. If we analyze them, in most cases, the shareholders would have been better off, if they just got the money in form of dividends. They still have the possibility to invest the dividends in a given company which, would be equivalent whit the company acquiring another company, or invest in the same company which is equivalent with share buyback. The reason why this is not quite true is because of taxes. Usually capital gains taxes are lower and they need to be paid, only after the financial instrument is sold. Dividends on the other hand are taxed at a higher rate, and the tax needs to be paid, at the end of the financial year when the dividend was issued.

The thing that we need to keep in mind that if a company does have high dividends but borrowed money to pay them, than something is not right, and we need to look out for value traps.

The historic minimum for dividends was reached in 2000 with a dividend yield of just 1.1%. The maximum dividend yield was reached in 1932 with 13.8%. The median and mean dividend yield for the past more than 100 years where near 4.4%.

If we take into account only the data starting from 2000, the mean and median values drop to 1.8% and the maximum value to 3.2%.

Based on the scatter plot, if somebody would have bought the S&P500 index only when the dividend yield was above 1.8% he did well, however there where only a few years when this was true.

The lowest dividend yields where in 2000 at the best time to sell, and the highest in 2009 the best time to buy.

With a longer investment time horizon it gets even more difficult to find a threshold when to invest, based just on dividends.

If we include all the available data, back to 1881 things get even more complicated.

In this case is harder to spot any correlation, still there is a slight upper trend in the scatter plot.

So the higher the dividends the higher returns we can expect. This is a valuable metric and can be included in a formula to compute the value of a stock.

For this many reasons mentioned above, dividends will be included just as a bonus. It will not count into the value of a company, however if a company has dividends will receive some bonus based on the dividend yield. This bonus can have a multiplier from 0 to 2 or 3.

If we analyze the whole time horizon for better results we should include the effect of the inflation as well, because during this long time horizon there where high inflation periods.