An Increasing Dividend, but Lower Dividend Yield?

Chart of the Week for September 14 - September 20, 2007

Historically, investors have viewed the primary purpose of a corporation as increasing shareholder wealth. One of the ways companies can increase wealth and returns for their shareholders is to pay out a portion of their profits in the form of dividends. Dividends most often take the form of cash dividends or stock dividends and are generally paid out quarterly, semi-annually or annually. Over time dividend payments, which are considered income, can be reinvested and increase the overall return of a stock. The positive effects of reinvesting dividends are evident when comparing the S&P 500 Index Total Return, which includes dividends, to the S&P 500 Index Price Return, which excludes dividends. As a result of dividends, the S&P 500 Index Total Return of 6.75% was 1.69% higher per year than the S&P 500 Index Price Return of 5.06% over the ten year period ending August 31, 2007.

The graph above compares the annual cash dividend per share for all of the S&P 500 companies to their dividend yield since 1960. While it is evident that companies increased their cash dividends per share over time, it is also just as clear that their dividend yield fell. Many investors use dividend yield to find the percentage of a stock’s purchase price that the company will return to shareholders in dividends. Dividend yield can be calculated by dividing a stock’s annual dividend by its share price. For example, if a stock pays an annual dividend of $2 and is trading at $40 a share, it would have a yield of 5%. In 1987, the dividend yield on the S&P 500 Index reached 3.17% and over the following 20 years, the dividend yield declined to 1.77% during 2006. In the late 90's and early-to-mid 00’s, increases in stock price significantly outpaced the increases in dividends, which sent the S&P 500 dividend yield down. According to The Wall Street Journal, one of the reasons dividends grew at a slower pace than stock prices was due in part to companies reinvesting profits back into company operations instead of distributing dividends to shareholders. Although dividend yields for the S&P 500 Index remain lower than the historical average, dividends continue to increase shareholder wealth by providing a source of current income and total return for the investor.

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