Dividend Yield - the stock market’s way of saying "here, take my money"

You know how I see the good old dividend yield? For me, it is the stock market’s way of saying, “here, take my money!”

A dividend yield, or more specifically dividend-price ratio of a share, is the dividend per share, divided by the price per share. It is also a company’s total annual dividend payments divided by its market capitalisation, assuming the number of shares is constant. You will often find it being expressed as a percentage. The dividend yield is used to calculate the earnings on investment (shares) considering only the returns in the form of total dividends declared by the company during the year.

The dividend yield ratio is the single most commonly quoted financial ratio and for good reason, it is a major analytic and a key indicator.
Generally speaking, a higher dividend yield has been seen as highly desirable among many traders as the high dividend yield is considered an excellent indicator that stock is either underpriced or that the company is not doing as well as it has in the past and that future dividends are not going to be high as previous ones. Likewise, a lower dividend yield is generally seen as a good indicator that the stock is either overpriced or that future dividends will be higher. Some traders will find a the higher dividend yield more attractive as it is an aid to marketing a fund to retail investors, or because they are unable to get any capital, which may be tied up in a trust arrangement while others may find a higher dividend yield unattractive as it increases their tax bill.

Lets outline a basic dividend yield strategy, some taxation benefits and some important terms so you know what is going on.

A Basic Dividend Yield Strategy

You may have heard of the Dogs of the Dow strategy, it became famous (or infamous) during the 90s because of how well it works and how easy (comparatively) it is to implement. This strategy was made popular by a book called Beating the Dow that was published in 1991 by Michael O’Higgins, who believes that the strategy outperformed the Dow Jones by an average of 6.18% per annum from 1973 – 1991, though it should be noted that the outcomes have not been so good since 1991.

At its core the strategy demands that you purchase the 10 highest yielding firms on the Dow Jones Index at the beginning of the calendar year, with a rebalance of your portfolio at this time. People who have used this strategy with great success believe that the large blue chip firms are the most sound and that the high dividend yield implies that there is a short term negative change in market sentiment. Thus, you will generally find that high yield firms are the ones that are closer to the near to the end of their business cycle and you will be more likely to see a larger capital growth from them than their lower yield rivals.

Taxation Benefits

Some dividends are distributed without any taxes paid on them but a number of companies pay dividends to investors AFTER they have paid the 30% tax on their profits. These dividends are spoken of being “franked”, and if you get a franked dividend then you will get a credit for the amount of tax that has already paid (this is often called Franking Credits or Imputation Credits).

Don’t get it? Hang on, here is how it works:

If a company pays you out a fully franked dividend of $70 that has a $30 franking credit with it then this means that the total dividend before any tax was paid was $100 (As in 30% of $100). You need to declare the full $100 in your income even though you actually only got $70 of it. Then when it comes to doing your taxes, say you were paying a 20% tax rate then you would need to pay $20 for the $100 you earned, but as the $30 has already been paid by the company before you got your dividend then you will actually get a tax refund of $10. Not a bad little trick and as with anything, when you scale it up it can be pretty nifty. Obviously, if your tax rate is above that of the company tax rate then you may need to pay more, meaning you need to operate with a good understanding.

Important Terms:

  • Ex-Dividend Date: This refers to share purchases that have been made after the cut off time that would entitle them to a dividend. The company's share price will generally drop by an amount roughly equal to the dividend.

  • Record Date: This refers to the day that share registries will work out how is entitled to the upcoming dividend. If you are a registered shareholder who bought before the ex-dividend date than that is you, well actually because share purchases take three business days to settle, the record date is set several business days after the ex-dividend date.

  • Payment Date: This refers to the day that you will be paid the dividend, which is generally a few weeks after the record date.

  • Dividend Reinvestment Plan (DRP): A number of companies let shareholders reinvest their dividends at a discount to the current share price using the DRP. This is a good way of growing your investment.

Watch INDX.GURU's CCO, Yvette Le Grew chat with Sky News - Technology Behind Business about disruption in the investment space.

Happy trading!

Tomer Garzberg

Growth Hacker