Sunday, January 6, 2008

the yield effect

An interesting article from the Motley Fool called Bear Market Buys, points out that when stock prices drop dividend yields increase because you are buying the same stream of dividends for a lower price point.

For example if stock ABC is paying $2.00/share in dividends, it would yield 4.0% when trading at $50/share, but yields 5.0% when trading at $40/share.

This is a key scenario that really allows you to take advantage of the power of dividend growth investing. Your success though, will depend on whether or not the company you bought continues to raise their dividend at a strong pace in the years ahead. If you buy a company that has an inflated current yield relative to its historical average yield, but then the firm fails to raise dividends swiftly as they have in the past your returns will suffer. I usually only follow companies that have histories of strong annual dividend increases, so if a company is yielding higher than average currently there is still a reasonable expectation that they should continue to place a priority on raising dividends. Having the wherewithal to continue to raise dividends at swift rates (8-12% annually), is always the result of the company growing earnings at these same rates going forward. It really always does come back to earnings growth, as I explained in 'equity investing is earnings growth'.

In the process that I use to select entry points for stocks, dividend yield as compared with the historical average dividend yield is only part of the total picture. I thought it would be interesting though to show some situations that are developing with respect to dividend yields with some stocks out there that have great histories of dividend growth, and just might be ripe for the picking.

Here are a few examples where the current dividend yield is significantly higher than the average yield calculated over the last 5 years:

Bank of America (BAC)........... 5 year avg yield = 3.8% current yield = 6.4%
Pfizer (PFE)........................... 5 year avg yield = 2.6% current yield = 5.5%
General Electric (GE).............. 5 year avg yield = 2.6% current yield = 3.4%
Bank of Montreal (BMO)........ 5 year avg yield = 2.8% current yield = 4.5%
Manulife Financial (MFC)....... 5 year avg yield = 1.8% current yield = 2.5%
United Parcel Service (UPS).. 5 year avg yield = 1.5% current yield = 2.4%
Bank of Nova Scotia (BNS)..... 5 year avg yield = 2.9% current yield = 3.9%
Masco Corporation (MAS)..... 5 year avg yield = 2.5% current yield = 4.5%

* Canadian bank information are from the U.S. traded versions.

4 comments:

pitz said...

Its kind of neat looking back on the dividend growth, and your yield on your original investment. For instance, I got many of my Shoppers Drug Mart shares at $18, and when they hike the dividend to 20 cents/share/quarter, the yield will be 4.5%, which finally makes my investment cash flow positive on an after-tax basis since I financed most of the original purchase (and interest rates are now dropping).

I'm sure, in a few years, you'll have some of your own examples, where the dividends now would be, for instance, enough to make payments on the money you borrowed (albeit indirectly, through your mortgage) to invest.

Anonymous said...

I use the long term historical low yield as one of the entry points. I find the 5 or 10 year averages as not long enough.

Example:

The historical highest yield for BAC has been 5%.

Dividends4Life said...

Good read. I am shopping now looking to counter balance all my bank stocks holdings. I actually ran some preliminary analysis on MAS at lunch today.


Best Wishes,
Dividends4Life

MG said...

pitz, one can only hope...

anon, where do you dig your data up?

D4L, MAS is certainly worth a look as it might just be a good alternative to Home Depot