Bothdividend yieldandtotal returnare terms used to describe the performance of a stock over a certain time period (usually one year), but they reflect different types of performance. Whether equity investors should focus on income generation, which includes dividend yield, or return is a contested topic in the financial world. In truth, the relative importance of each measurement likely depends on your individual circ*mstances and investment horizon. This does not mean you have to neglect one in favor of the other; it is wiser to consider both before selecting an investment.
The Importance of DividendYield
Dividendsare the portion of a company's profits that are distributed to shareholders. It is considered a sign of clear financial health and confidence for a company to pay out dividends, which are usually independent of the share price. The dividend yield is afinancial ratiothat represents the dividend income per share, divided by the price per share. For example, a stock priced at $100 per share that receives a dividend payment of $8 is said to have a yield of 8%.
For long-term investors, dividends can be very powerful, because they can be reinvested and used to purchase more shares, meaning the investor does not have to commit more of his or her resources to increase his or her equity holdings. Other investors rely on yields to produce a stream of income from their investments. Though not quite as reliable as fixed-income investments such as bonds, dividend-producing stocks can be quite valuable in this way.
Yield, however, can be misleading. Some companies continue to pay yields even when they are operating at a short-term loss, while other companies pay out yields too aggressively and fail to reinvest enough profit to sustain operations down the road.
The Importance of TotalReturn
Totalreturn, often referred to as "return," is a very straightforward representation of how much an investment has made for the shareholder. While the dividend yield only takes into account actual cash dividends, total return accounts for interest, dividends, and increases in share price, among other capital gains.
Investors can also look at thedividend-adjusted return, which is part of the total return. This figure includes the stock's price appreciation and paid dividends. To determine if a trade turned a true profit, the investor will also need to consider capital gains and dividend income taxes in the dividend-adjusted return.
On the surface, this appears to provide a more encompassing, and therefore useful, performance metric than the dividend yield. However, a return is entirely retrospective, and share prices can increase for a huge number of reasons. It is typically more difficult to project future investment performance from the stock's return than from its dividend yield.
Which Is More Important?
The importance is relative and specific to each investor. If you only care about identifying which stocks have performed better over a period of time, the total return is more important than the dividend yield. If you are relying on your investments to provide consistent income, the dividend yield is more important. If you have a long-term investment horizon and plan on holding a portfolio for a long time, it makes more sense to focus on total return. However, the evaluation of a company for potential equity investment should never come down to just these two figures; rather, look at the company's balance sheet and income statement, and perform additional research as well.
FAQs
If you are relying on your investments to provide consistent income, the dividend yield is more important. If you have a long-term investment horizon and plan on holding a portfolio for a long time, it makes more sense to focus on total return.
What is more important, dividend or yield? ›
While the dividend rate shows the absolute amount of dividend paid per share, the dividend yield factors in the stock's current price, offering a more insightful measure of the return on investment.
What is the significance of dividend yield? ›
Dividend yield is a ratio that shows you how much income you earn in dividend payouts per year for every dollar invested in a stock, a mutual fund or an exchange-traded fund (ETF). To put it another way, dividend yield is a security's annual dividend payment expressed as a percentage of its current price.
What is the most important in common form of dividend? ›
Cash dividends and stock dividends are the most common forms of dividends. Bond dividends and scrip dividends are less common. Cash dividends are the most common and important form of dividends as they provide immediate income to shareholders.
What is the relationship between dividend yield and return on equity? ›
Dividends and return on equity are closely linked, as both concepts revolve around the profitability and financial performance of a company. Dividends are one way for a company to distribute its profits to shareholders, which can impact the return on equity.
What is the difference between total return and dividend yield? ›
Total return, often referred to as "return," is a very straightforward representation of how much an investment has made for the shareholder. While the dividend yield only takes into account actual cash dividends, total return accounts for interest, dividends, and increases in share price, among other capital gains.
What is the disadvantage of dividend yield? ›
The following are the disadvantages: In case the dividend data is old or is based on erroneous information, the evaluation of a stock based on this information is incorrect. Sometimes high yield can be misleading since it may indicate a falling stock price instead of an increase in dividend payment.
What is a good annual dividend yield? ›
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
What does dividend yield tell you about a company? ›
What Does the Dividend Yield Tell You? The dividend yield is a financial ratio that tells you the percentage of a company's share price that it pays out in dividends each year. For example, if a company has a $20 share price and pays a dividend of $1 per year, its dividend yield would be 5%.
What are the advantages of dividend yields? ›
With dividend yield, investors can evaluate the possible profit for every dollar invested, and analyze the potential risks of investing in a company. If you are into trading stocks, and shares, make sure to do it with a trading company with access to many global exchanges.
10 Best Dividend Stocks to Buy
- Verizon Communications VZ.
- Johnson & Johnson JNJ.
- Altria Group MO.
- Comcast CMCSA.
- Medtronic MDT.
- Duke Energy DUK.
- PNC Financial Services PNC.
- Kinder Morgan KMI.
Five of the primary reasons why dividends matter for investors include the fact they substantially increase stock investing profits, provide an extra metric for fundamental analysis, reduce overall portfolio risk, offer tax advantages, and help to preserve the purchasing power of capital.
What is the most popular type of dividend? ›
Cash Dividends Are by Far the Most Common.
Does dividend yield predict stock returns? ›
Abstract. The power of dividend yields to forecast stock returns, measured by regression R2, increases with the return horizon.
What is the relationship between yield and return? ›
The yield is the income the investment returns over time, typically expressed as a percentage, while the return is the amount that was gained or lost on an investment over time, usually expressed as a dollar value.
What is the difference between total return and dividend-adjusted return? ›
The investor may wish to calculate dividend-adjusted return. This figure considers both the stock price appreciation and its dividends. The dividend-adjusted return provides a more accurate valuation of a stock's return. Total return determines an investment's true growth over time.
Does high yield mean high dividend? ›
A high dividend yield can be appealing since you're getting more income per dollar invested, but a high yield isn't always a positive thing. It could mean that the company's stock price has been falling or dividend payments have been increasing at a higher rate than the company's earnings.
Should yield on cost be higher than dividend yield? ›
Since most securities rise in value over time, the yield on cost is often, but not necessarily, higher than the current dividend yield.
Should you buy stock with high dividend yield? ›
“One mistake to avoid,” Cabacungan says, “is to buy a company's stock simply because it issues a high dividend.” If the company has leveraged excessive debt to fund the dividend, it could come at the expense of future profitability and hurt growth prospects.
What is a good dividend payout ratio? ›
So, what counts as a “good” dividend payout ratio? Generally speaking, a dividend payout ratio of 30-50% is considered healthy, while anything over 50% could be unsustainable.
