Another Way To Harvest Yields: Common Stock Dividends

Wednesday, November 4, 2009

Apple harvestInvestors have been scrambling to increase their yields, even going so far as to take on junk bond and emerging market debt risks. It’s time to revisit the strategy of collecting dividends. High quality common stocks are offering attractive yields, plus there is the potential for real growth.

Here’s how to look at the offerings…

There are three key measures used to examine common stock yields. These are typically forward-looking, as explained below.

Dividend Yield: Usually the latest declared quarterly payment times four, divided by the current price. Companies with growing earnings often increase the dividend payment once a year. A dividend decrease is a serious negative event to investors, so management carefully considers the ability to maintain the dividend into the future before committing to a new level.

Earnings Yield: The estimated annual earnings per share divided by the current price. (This figure is the inverse of the price/earnings ratio. For example, a P/E ratio of 20 is an earnings yield of 1/20 = 5.0%.) Earnings yield can be thought of as total return per share, with a proportion being paid in dividends to shareholders and the rest being reinvested in the company. The goal of the reinvested earnings is to increase the value and earnings of the company, leading to increased dividends.

Payout Ratio: The proportion of earnings paid out as dividends. A rough rule of thumb is that an established company in a stable industry operating in normal economic times will consider a 50% payout ratio. Growing companies in growing industries (like Microsoft) tend to pay out less so that they have more funds to invest in expansion and research & development. Companies with cyclical earnings (like Caterpillar) will allow their payout ratios to fluctuate rather than raising and lowering their dividend payments.

Below are the yields and payout ratios for fifteen leading companies from different industries. (The companies are examples only and should not be considered recommendations.)

Dividend yield table

This diversified list of well-known companies provides a good look at the state of the stock market today. Overall, dividend and earnings yields are attractive, and payout ratios look appropriate, providing protection for the dividends as well as resources for the company.

So, a diversified portfolio of dividend-paying common stocks is an investment well worth considering. It could provide a growing yield over time.

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