Lesson 9 of 43: Dividend Stocks: How Yield & Income Can Boost Your Investing Profits

  • The dividend yield is the most important metric to understand how much you’ll make in dividends each year vs. how much you’ll have to pay to buy a share.
  • Most dividend yields range from 1% – 6%, but some companies pay less than 1% and certain kinds of companies can go much higher.
  • We show how important dividends are to your investing profits and provide links to a stock screener that can filter the best dividend stocks.

Put simply, a dividend is a cash payment from a company to its shareholders.

Dividends are usually paid quarterly and companies strive to keep them relatively steady (or growing) over time.

While it may seem like a strange concept to collect an income check from a company just for buying their stock, it actually makes sense when you think about what it means to purchase a company’s shares.

When you buy a share of stock, you’re investing your money to buy a small piece of a company, and in return, that company will send you a small portion of their profits (since you’re now an owner).

In general, mature companies that are growing slowly tend to pay a dividend while companies that are growing quickly tend not to pay a dividend.

The reason for this is that fast-growing companies have many ways they can invest their profits to drive further growth and gains in their stock price. So their profits are best reinvested in the business.

In contrast, slow-growing companies have few places to reinvest their profits, so they opt instead to return them back to shareholders in the form of dividends. 

There are certainly exceptions to this rule, and one type of company isn’t necessarily better than the other.

As of 11/1/18, there are 2,972 public companies trading in the U.S. that pay some kind of dividend to their shareholders.

To see how many stocks pay dividends by market cap size, check out our article: “Which Stocks Pay Dividends? Small Cap vs Large Cap for High Dividends.”

Dividend Yield: How To Grade a Dividend

When it comes to analyzing dividends, there’s one key metric that stands out above all the rest: dividend yield.

Dividend yield measures the total amount of dividends (per share) a company is expected to pay over the next year divided by its current share price.

Here’s the official dividend yield formula:

When you look at dividend yield, you’re basically asking, “How much income will you provide to me as an owner for the next year vs. how much will it cost me to buy a single share of your stock?”

Dividend yields can range from basically 0% up to 10% and beyond. That said, most dividend yields typically range somewhere between 1% – 6%.

Let’s show an example.

Let’s say you’re considering buying Walmart (WMT) stock. As of 11/1/18, their current dividend yield is 2.07%.

We arrive at that yield because if you invest $100.58 to buy a single share of Walmart, they will pay you $2.08 worth of dividends over the next year ($2.08 in dividend income / $100.58 cost per share = 2.07% dividend yield).

Not bad, but we can do better.

Let’s look at a classic “high dividend” stock: Exxon Mobil (XOM)

It will cost you $80.67 to buy one share of Exxon Mobil, which will earn you $3.28 in dividend income over the next year. That’s a 4.12% dividend yield.

Now, $3.28 may not sound like much, but remember that’s how much you will collect for every share you own. So, if you buy $50,000 worth of Exxon Mobil stock, you’ll earn roughly $2,060 each year in dividend payments ($50,000 in Exxon Mobil stock x 4.12% dividend yield).

You can see why some investors like dividend stocks.

Remember, it doesn’t matter how big or small a company’s dividend payment is each quarter. What matters is the dividend yield, which is the ratio of that dividend payment to the cost per share.

For example, let’s compare to imaginary stocks:

  • Stock A: Pays a $10 annual dividend / $1,000 stock price = 1.00% dividend yield
  • Stock B: Pays a $1 annual dividend / $20 stock price = 5.00% dividend yield

It’s tempting to think Stock A’s $10 annual dividend is better than Stock B’s $1 annual dividend. But it’s not. Stock B has 5x the dividend yield of Stock A.

Or, you can think of it like this:

If you invested exactly $50,000 into Stock A or Stock B, Stock B would pay you far more in dividends each year. That’s why it’s a better dividend-paying stock than Stock A.

One thing to keep in mind is that when a stock’s price goes up, their dividend yield falls. This is because you now need to pay more to buy a share but you’ll still collect the same dividend.

But it works the other way too. When a stock’s price falls, their dividend yield goes up. You can now “buy” that same annual dividend income at a cheaper price per share.

We’ll cover this concept extensively in a future lesson, but some stocks with high dividend yields can be a great investment because their dividend income is high (compared to their price) and their unusually high dividend yield may be a sign their stock is currently undervalued.

Dividend Yield of the S&P 500

Many stocks in the S&P 500 pay a dividend, and overall the S&P 500 currently has a dividend of 1.83% as of 11/1/18.

Hartford Funds shows an interesting view of how the yield of the S&P 500 has changed over time:

The yield of the S&P 500 has changed over time and is a function of a number of things, including each company’s debt and cash situation, their preference for dividends vs. buybacks, and their stock price (remember, half the yield formula is the price of the stock).

Looking at another chart from Hartford Funds, we can see that dividend yields on stocks are almost as good as the yield on corporate bonds.

This is a good example of why some investors prefer dividend stocks over bonds. They can collect income almost as high as a bond, but they also have a chance to profit when the stock’s price appreciates.

How Important Are Dividends to Your Profits?

History shows that dividends make up a critical portion of your long-term stock profit.

On average, dividends have contributed roughly 40% of the total return of the stock market.

What does that mean?

Let’s say you invest $100,000 into a portfolio of good stocks and leave it there for ten years. You check back after ten years and you’ve done quite well: your money has doubled to $200,000.

In order to figure out how you made so much profit, you dig up all your account statements for the last 10 years.

What you find is that of the $100,000 you earned in the market, roughly $40,000 came from collecting dividend income and the other $60,000 came from your stock’s prices going up.

Based on your analysis, you’d say that 40% of your total return came from dividends and 60% of your total return came from price appreciation.

Historically, dividends have contributed about 40% of total stock market returns. But this changes greatly through different periods.

This is illustrated in a chart from Hartford Funds, which charts how much dividend income contributed to total stock market return in each decade.

When stock prices struggled or declined, dividends contributed a greater portion of the total return (for example, see the 1970s when dividends made up 73% of the total return).

On the other hand, in decades when stock prices appreciated strongly, dividends were responsible for much less of the total return (for example, see the 2010s, where dividends have contributed just 17% of the total return).

While dividends tend to vary a little over time, stock prices can change a lot in the short term.

Historically, dividends have contributed a significant portion of the stock market’s total returns. So it’s important you consider dividends when buying stocks.

Reinvesting Dividends Compounds Your Wealth Fast

As we saw above, dividends are valuable because they make up a meaningful portion of total returns. But there’s another way dividends can build wealth for your portfolio.

Steadily reinvesting dividends allows you to add to your positions and put more into the stock market over time.

What does that mean?

When you receive a dividend payment, it’s usually deposited into your account as cash. If you leave that payment in cash, it’s just sitting on the sidelines, not working for you, losing value to inflation.

But if you take that cash and reinvest it into the stock market, it will allow you to steadily add to your investment in the market over time.

So, how much does reinvesting dividends matter in the long term?

A lot.

This chart from Hartford Funds shows the difference between the S&P 500 with no dividends vs. the S&P 500 with dividends reinvested.

The difference is astounding. From 1960 – 2017, $10,000 invested in the S&P 500 without any dividends becomes $460,095, which at first seems like a great return.

But when you factor in reinvested dividends, the S&P 500 total return becomes an incredible $2,571,920 – that’s over 5x as much money!

It’s important to reinvest dividends in some way.

Some methods call for passive reinvestment, such as automatically buying more of the stock that paid the dividend through a dividend reinvestment plan (DRIP). Other methods focus on more active reinvestment of dividends.

We’ll explore both strategies (and more) in a future lesson on dividends.

Stock Dividends: Lesson Summary

Dividend stocks provide steady income over time and can contribute a lot to building your long-term wealth.

If you want to research dividends, you can use the screener from Finviz to filter for stocks with a yield greater than 0%.

In a future lesson, we’ll cover how to find the best dividend stocks to maximize your profit and reduce your losses (Lesson 26 of 43 (Dividend Investing): A Step-by-Step Guide to Picking the Best Dividend Stocks).

For now, let’s close by reviewing these important dividend concepts:

  1. Dividends are regular cash payments from a company to its shareholders.
  2. Dividends are typically paid out quarterly (however, they can range from a single one-time special dividend up to regular monthly payments)
  3. Dividend payments usually remain pretty steady or trend gradually upwards over time (however, they can sometimes decline if a company is struggling financially)
  4. The dividend yield is the most important metric to understand how much you’ll make in dividends each year vs. how much you’ll have to pay to buy a share.
  5. Most dividend yields range from 1% – 6%, but some companies pay less than 1% and certain kinds of companies can go much higher.
  6. Historically, dividends have made up roughly 40% of the stock market’s total returns.
  7. Reinvesting dividends adds tremendous compounding power to your investing.

Dividends play an especially important role when the stock market is crashing. We’ll explain why next: Lesson 10: Stock Market Crashes: Why Markets Decline & How to Survive



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Author

Todd Lincoln

Author

Passionate stock market investor with deep experience trading small cap, dividend, and growth stocks.

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