Dividend yields, explained
Dividend-paying stocks tied to healthy and growing companies can be great wealth-builders. You can generally count on dividend payments to arrive regularly, in both growing and ailing economies — and you can expect them to increase over time, too.
Companies can use their profits in a variety of ways. Younger, faster-growing businesses often reinvest most of their profits to further their growth — perhaps by hiring more people or building more factories. More established companies may not need every dollar of profit, so they often pay dividends to shareholders.
To invest in dividend payers effectively, you'll need to understand what a dividend yield is. It's essentially a fraction, expressed as a percentage, reflecting the portion of a stock's price that's paid out in dividends annually.
Consider Starbucks. It was recently trading for around $95 per share, while paying $0.49 per share in quarterly dividends (that's $1.96 annually). To determine the dividend yield, simply divide $1.96 by $95, and you'll get a little over 0.02 — or expressed as a percentage, 2%. So if you buy a share of Starbucks at that price, you'll earn a 2% return on your investment each year in dividends alone.
Over the past five years, Starbucks has hiked its dividend — the payout, which is not the same as the yield! — at an average annual rate of nearly 16%, roughly doubling it in that time.
The best dividend payers also reward shareholders via a stock price that rises over time. Starbucks' stock price, for example, has grown by about 341% over the past decade, averaging 16% annually — and that excludes dividends.
Dividend yields fluctuate along with the stock prices they're tied to. As a stock price rises, the yield falls, and vice versa. If Starbucks' stock fell to $50 per share, for example, its yield would be $1.96 divided by $50, which is nearly 0.04, or 4%.
Unusually fat dividend yields may be attractive, but make sure the reason for a high yield isn't that it's tied to a stock that crashed for good reasons.