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How to Correctly Use Stock Indicators
Part 6: The Dividend Yield
In principle, a company has two options for what to do with a profit: It can be reinvested (capitalized) in the company, or it can be distributed to shareholders as a dividend. If the profit is reinvested in the company and is successful, the company will grow in the long term, leading to even higher future profits. Ultimately, this has a positive impact on the stock price.
High-growth companies often do not pay dividends:
A high and relatively constant dividend yield is therefore typical for companies operating in a mature or stagnant market, which see little potential for further growth. This often applies to companies in the utility, telecommunications, and insurance sectors (so-called value stocks). Stocks of these companies are therefore also referred to as dividend stocks. In contrast, a company operating in a rapidly growing market or seeing significant growth potential for itself will either not distribute any dividend or only a small one (so-called growth stocks). This is typical, for example, for companies in the technology, internet, and biotechnology sectors.
What are the pitfalls of dividend yield?
Are stocks with a high dividend yield always worth buying? No, it’s not that simple. Dividends are usually directly dependent on the company’s profit, and the distribution can therefore fluctuate significantly. As soon as the profit decreases, the dividend will eventually be cut. An exceptionally high dividend yield can thus be a warning sign of an imminent earnings slump and a declining stock price. The dividend yield based on the company’s last profit distribution may still be high, but it will decrease in the future, as the dividend will also have to be cut. Therefore, for a purchase decision, you should base the calculation of the dividend yield not on past dividends paid, but on the dividends expected in the future. However, forecasts can also be wrong.
Facts about the dividend:
- The dividend refers to the profit distributed to the shareholders.
- The amount of the dividend per share is determined by the board of directors, upon the proposal of the management, at the annual general meeting.
- The distribution is usually made annually, but sometimes also quarterly or monthly.
- The dividend yield is calculated as the quotient of the dividend divided by the current stock price: Dividend yield = Dividend (gross/net) / current stock price.
Our Conclusion:
Stocks with a high dividend yield are considered better protected against price setbacks. However, investors often, and unfortunately, wrongly feel secure. Dividend forecasts are often cut only after the fact. An apparently high dividend yield can be misleading. You should also look at other stock indicators, such as the P/E ratio and the book value.
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