Analyzing Low Dividend Yields in Stocks
Investors in stocks turn profits through both capital gains and dividends. Capital gains refer to share price appreciation. Corporations also return capital back to shareholders, in the form of dividends. Conservative savers often target dividends as means to generate regular income. A low dividend yield, however, may not necessarily be indicative of a poor investment. Corporations that retain the majority of their earnings, rather than paying out hefty dividends, are more so likely to be poised for growth.
Calculating Dividend Yield
Dividend yields are somewhat comparable to interest rates, as both calculations relate to expected investment income per a set amount of principal. Dividend yield is the result of dividing a stock’s expected annual dividend payment by its current share price. For example, Stock X is a $100 stock that pays a 50-cent quarterly dividend, or $2 annual dividend. Stock X therefore features a 2 percent dividend yield. A $1,000 Stock X investment may yield $20 in dividend payments over the next year.
Lower Dividend Yields
Lower dividend yields may be the result of strong share price appreciation, in conjunction with the corporation refusing to authorize larger dividend payouts for shareholders. In the above example, $100 Stock X was scheduled to pay out a $2 annual dividend that resulted in a 2 percent dividend yield. In six months, Stock X may actually double in value – without increasing its dividend. At that point, the stock’s dividend yield would have dropped to 1 percent ($2/$200 = 1 percent).
Investors generally prefer that small, growing companies feature low dividend yields. Instead of paying large dividends, these emerging companies can best grow shareholder wealth by reinvesting profits back into their respective businesses to finance expansion. For that reason, small capitalization stocks valued at less than $2 billion and cutting-edge technology firms generally make minimal dividend payments, if any.
Low dividend yields throughout the stock market may signal that investors are now favoring aggressive growth stocks, rather than conservative investments that pay large dividends. In August 2000, the S&P 500 recorded a record low 1.11 percent dividend yield – as a benchmark for U.S. stocks. Dividend yields fell sharply throughout the 90’s technology boom, when speculators chased quick stock market profits.
Savers more so concerned with investment income may compare stock market dividend yields to prevailing interest rates. Fixed income assets become more attractive, if interest rates were to rise significantly, while dividend yields remain low. For example, a conservative saver may prefer to own bonds offering 5 percent interest rates, instead of buying into an individual stock carrying a 1 percent dividend yield payout. Bonds, however, offer far less upside capital gain potential relative to the aggregate stock market.
Be advised further that corporations aggressively slash dividend payments during the initial stages of a turnaround. At that point, the corporation may use the free capital to pay down debt and reinvest into long-term assets, with the intent of ultimately resuming a growth trajectory. From there, a growing business is more likely to reward its shareholders with regular annual dividend increases. On August 16, 2012, Apple made its first dividend payment in seventeen years.