A dividend yield tells you how much a company paid out compared with its share price. It doesn't tell you how the investment went. For that you need total return: the change in the share price plus the dividends received, as a percentage of what you paid. This article works through both with simple numbers.
The three measures
- Dividend yield: dividends per share over a period, usually the last twelve months, divided by the share price. A share at $20.00 that paid $1.00 in the last year has a trailing yield of 5%.
- Price change: the end price less the start price, divided by the start price.
- Total return: price change plus dividends received, divided by the start price.
Yield is a ratio at one moment. Total return describes what actually happened to your money over a period.
A worked example
Two shares each cost $10.00 at the start of a year. Over the year:
- Share A pays $0.80 in dividends. Its price falls to $8.50.
- Share B pays $0.30 in dividends. Its price rises to $10.90.
On the purchase price, Share A yielded 8% and Share B 3%. At first glance A looks like the better income investment. Now the full picture:
| Share A | Share B | |
|---|---|---|
| Start price | $10.00 | $10.00 |
| Dividends received | $0.80 | $0.30 |
| End price | $8.50 | $10.90 |
| Price change | −15% | +9% |
| Total return | −7% | +12% |
Share A's total return is (8.50 − 10.00 + 0.80) ÷ 10.00 = −7%. The dividends softened the loss but didn't cover the fall in price. Share B's total return is (10.90 − 10.00 + 0.30) ÷ 10.00 = +12%, even though it paid less than half as much in dividends.
An investor who needed $0.80 of income from Share B could have sold a little of the holding. Whether income arrives as a dividend or a sale, the wealth left at the end is what total return measures.
Why a high yield can come with a falling price
Look at Share A's yield again at the end of the year. It paid $0.80 over the last twelve months and now trades at $8.50, so its trailing yield is 0.80 ÷ 8.50 = 9.4%. The yield went up because the price went down.
That is common. A trailing yield divides last year's dividends by today's price. When investors expect a company's profits, and so its dividends, to shrink, the price falls before the dividend does. The trailing yield rises and the share can appear near the top of a list sorted by yield just as the market is pricing in a cut.
Suppose Share A then cuts its dividend to $0.40 a year. At $8.50 the yield on the new dividend is 4.7%, not 9.4%. The high yield was describing the past.
Ways to read a high yield more carefully:
- Compare the yield with the company's own history. A yield far above its usual range usually reflects a lower price rather than a higher dividend.
- Check the payout ratio, dividends per share divided by earnings per share. A ratio above 100% means the company paid out more than it earned that year.
- Check whether free cash flow (operating cash flow less capital expenditure) covered the dividends. Earnings can include items that aren't cash.
- Look at the dividend history for cuts. A record of steady or growing payments is information, though not a promise.
How reinvestment matters
Reinvesting dividends means using each payment to buy more shares, which then earn dividends of their own. The effect is small in one year and large over many.
Take $10,000 in a share whose price rises 3% a year and which pays 4% of its value in dividends at the end of each year, for ten years. Ignore tax, brokerage and changes in the share's prospects.
- Spending the dividends. The shares grow to $10,000 × 1.03¹⁰ = $13,439. The dividends add up to $4,586 over the decade, because each year's payment is 4% of a slowly rising value. Together: about $18,025.
- Reinvesting the dividends. Each year the holding grows 3% from the price and another 4% from new shares, or 7% in total. After ten years: $10,000 × 1.07¹⁰ = about $19,672.
The difference of about $1,647 is the dividends earning their own returns. Over twenty or thirty years the gap widens a great deal, because it compounds.
Two consequences follow. First, a price chart understates the long-run return of a dividend-paying share, because the dividends aren't in it. Second, the same applies to price indices such as the S&P/ASX 200 and the S&P 500: they track prices only. Total-return (or accumulation) indices assume dividends are reinvested, and they are the fairer yardstick for a portfolio that receives dividends.
Franking credits
Many Australian companies pay franked dividends, which carry a credit for company tax already paid. Some sources quote a "grossed-up" yield that adds the credit to the cash dividend, so the same share can show two different yields. Check which one you're looking at. Whether the credit is worth its full value to you depends on your tax position.
Putting it together
- Yield is a snapshot: last year's dividends over today's price.
- Total return is the outcome: price change plus dividends.
- A high trailing yield can be a sign that the price has fallen in anticipation of a lower dividend.
- Reinvested dividends compound, so compare portfolios with total-return measures and total-return indices.
On Take Profits, the portfolio tool reports total return and a money-weighted return that include the dividends you record, and the income plan shows each holding's dividend history and payout coverage beside its payments.
This article is general information, not advice about any particular investment.