Do you use current dividend or cost of purchase (COP) dividend yield?
If a stock currently trades at $10 and currently pays a $0.40 annual dividend; how come investor A says the stock dividend yield is 4% and investor B (who purchased the stock a while ago) says the stock dividend yield is 5%? That’s because investor A use the current dividend yield and investor B might use his cost of purchase (COP) dividend yield.
Which one should they both use? The current or the cost of purchase dividend yield? Before answering this question, we should look at both definitions.
The current dividend yield is used to quantify in percentage the payout made by a company compared to its stock price. Let’s take McDonald’s Corporation example. If you put the ticker “MCD” in Google Finance, you will get the following screen:
In the right column, you get the current dividend payout (Div: $0.77) along with the current dividend yield (yield: 3.33%): $0.77/3.33. If the dividend yield is calculated by dividing the dividend payout by the stock price, how does $0.77 divided by $92.56 give 3.33%?
That’s because Google Finance shows the quarterly dividend. Since most dividend stocks pay their dividend on a quarterly basis, you need to multiply the payout by 4 in order to get the current dividend yield. Therefore:
$0.77 * 4 = $3.08 in dividend payout per share.
$3.08 / $92.56 = 0.03327 or 3.33%
The current dividend yield ofMCDis 3.33%. If the stock would rise tomorrow morning to $96.25 due to impressive quarterly results, the current dividend yield would automatically drop ($3.08/96.25 = 3.20%). Therefore, if you use the current dividend yield to describe a stock, remember that this percentage will change every day.
Cost of Purchase Dividend Yield
The other way to calculate a stock dividend yield is by using the very same formula (Dividend payout / stock price) but using the current dividend payout divided by the stock cost of purchase value. This measure gives your personalized dividend yield since it is based on your transaction. Instead of going on Google Finance to findMCD’s current dividend yield, you can calculate your own dividend yield on this stock.
If you bought MCDwhen the stock was at $82, the current dividend payout is still $3.08 per share today. However, your own dividend yield is much higher:
$3.08 / $82 = 0.0375 or 3.75% dividend yield.
When the stock was at $82, it wasn’t probably paying $3.08 per share. However, if you are a patient dividend investor and hold the stock for a while, your cost of purchase dividend yield will be much higher than the current dividend yield. This often makes the dividend investor think he is sooooo smart.
What Influences the Dividend Yield?
Going back to the dividend yield formula, there are 2 metrics used to make the calculation: The Dividend payout and the stock price.
Therefore, if one or the other (or both!) move, the dividend yield will change. The use of current dividend yield can be misleading when there is a huge movement from either the dividend payout or the stock price. Let’s take Avon (AVP) example:
When you look at the current dividend yield, you see an attractive 5.29%. Who would not like to buy a high paying dividend stock like this one? While the dividend yield seems interesting, you must check out why it’s so high. Technically, only 2 answers can be given:
#1 There is a huge dividend increase and the stock value didn’t go up
#2 There is no dividend payout difference but the stock value went down
Let’s see if we can find a quick answer by looking at the year-to-date stock graph:
As you can see at the bottom, the quarterly dividend of $0.23 hasn’t been modified since the beginning of the year. However, the stock value has gone through some kind of rocky road. But if you look at the year-to-date stock return, it’s pretty flat. Therefore,AVPwas paying a 5%+ dividend back in January. Unfortunately, we can’t find our answer from the stock graph. But the answer can be found if we look further into the past:
The 5 year graph shows that the dividend payout has increased from $0.19 quarterly to $0.23. At the same time, the stock went from $38.40 to $17.40. A dividend increase combined with a stock plunge eventually leads to a pretty high (and not so interesting) dividend yield. If you had purchased the stock when it was at $38.40, your cost of purchase dividend yield is showing 2.40% ($0.23*4 / $38.40). Your own 2.40% dividend yield is 50% lower than the current dividend yield.
When You Should Use Current Dividend Vs COP Dividend Yield
So now that you know the difference between current dividend yield and cost of purchase dividend yield, which one should you use?
I personally use both… lol!
I use the current dividend when I’m about to purchase a stock. I obviously screen the financial statement and use a stock analysis template to make a sound investment decision. The current dividend yield will tell me how much, at the time of making the trade, I will earn in dividends.
Then, when I look at my overall portfolio, this is when I use the cost of purchase dividend yield. Personally, I would rather know how much yield I’m getting out of my investments (i.e. money that came directly out of my pocket) than knowing how much my portfolio is currently paying. Also if you hold the stock for several years, you will be able to quantify the power of dividend growth. For example, Coca-Cola (KO) has always been paying a current dividend yield of 2-3% but it has been doubling its dividend payout every 6 years or so. Therefore, if you hold the stock long enough, you will get aCOP dividend yield of 6%+ on this stock.
Both are important, but the return on my investment matters the most.
Do you use current dividend or cost of purchase dividend yield?
disclaimer: I do hold MCD & AVP in my portfolio