Dividents and Yields

There are many investors who buy stocks with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.

It is illogical to draw a distinction between capital appreciation and dividends. Money is money it doesn't really matter whether it comes from capital appreciation or from dividends. A wise investor is primarily concerned with the total returns on his investment he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long term capital appreciation because of tax considerations.

Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth. On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends, In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends. On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade off between capital appreciation, and income.

Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's stocks. This relationship is best expressed by the ratio called yield or dividend yield:

Yield = Dividend per Stock / Market Price per Stock X 100

Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.

The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your stocks. Average Yield figures in India usually vary around 2 per cent of the market value of the stocks. If you have a stock portfolio consisting of stocks belonging to a large number of both high growth and high dividend companies, then on an average your dividend income is likely to be around 2 per cent of the total market value of your portfolio.