Dividend yield and capital gains relationship

Do Total Returns = Dividend Yield + Dividend Growth? | Seeking Alpha

dividend yield and capital gains relationship

The taxes charged on dividends and capital gains should also for the relation between dividend yield and interest on own capital on the one. In investing, what really matters is the total return on investment. In the case of stocks, it is usually a combination of dividend yield and capital. I provide a discussion and evidence that the relationship predicted by this model is dubious at best. Total returns = Capital gains + Dividends.

New Zealand investors have a longstanding obsession with portfolio income; a bias which is exacerbated in a low interest rate environment. Meeting a specific cash flow need is an important element of portfolio management. In many cases, taxable investors with a cash flow need are better off minimising portfolio income.

Investors drawing down on their portfolios e. Income typically interest and dividend payments Cash from the sale of securities There are a number of factors to contemplate when determining how you might best use these components of cash flow to meet a specific need.

However, investors often gravitate toward income investments before properly considering all the relevant issues, which can result in a less efficient investment solution. High dividend yield helps you avoid eating up your investment base to generate cash flow Dividends offer protection on the downside, and mitigate the drop in down markets High-dividend-yielding shares constitute a less risky investment because of the regular payments Dividend-yielding shares are worth more because they offer dividends We argue that companies are valued based on their earnings.

Perhaps the best way to think of this is as a scale. To increase one side of the scale dividendsyou must balance it by decreasing the other side of the scale share price. The more earnings distributed as dividends, the less earnings reinvested in the business for future growth. In short, what an investor gains as a dividend they lose in the value of their remaining shares.

BNL Dividend Policy:

What does matter however, is the ability of a business to reinvest earnings their investment policy and the taxes investors pay as a result of which pocket the earnings fall into. We show that investors should prefer taking capital gains, as they are a more tax efficient means of raising cash.

dividend yield and capital gains relationship

So why are they so valuable, if dividends are so important? It only takes a cursory read of national newspapers to realise that dividends are the sacred cow of the New Zealand investment landscape. Conventional wisdom dictates that the regular payment protects you on the downside, because if the share price declines, at least you have your dividend cheque. While this logic attracts many investors, it is empirically flawed. Dividend payments are not created out of thin air.

When dividends are paid, the distributions reduce the value of the company by the amount of the dividend. With a dividend, you may not have actually sold the stock yourself, but the economic impact is essentially the same as if you had. Another common misconception is that dividends offer protection on the downside and mitigate falls in down markets.

However, consider that if the company did not pay a dividend, the price would have dropped less. You would obviously be out the cash from the dividend payment, but in both the dividend and no-dividend scenario, the total portfolio has dropped by more or less the same amount.

What Is More Valuable? Dividend Yield, Or Capital Appreciation?

While more recent papers suggest that dividends can affect firm value, this is more a result of what paying dividends signals to investors, rather than the dividends themselves. This signalling, however, relates more to changes in dividend policy i.

This misconception leads to the view that high-dividend-yielding companies are more profitable and less risky than non-payers when in fact, dividends are often not related to profits. Very profitable firms may not pay dividends e.

Conversely, some companies or trusts pay dividends or distributions in excess of profits. The latter case is unsustainable in the long run. Furthermore, high-dividend-yielding stocks may in fact be riskier companies.

  • Do Total Returns = Dividend Yield + Dividend Growth?

Market efficiency suggests that the price, rather than the dividend, contains the information about the prospects for a company and its expected future cash flows. The dividend discount model DDM shows how a high yield can result from: High risk companies have low prices because investors consider the future prospects of the firm to be less bright.

So in very simple terms, high yielding shares can be a direct result of increased risk. Not necessarily — only if an investor is aware of the risk and has chosen it purposefully, rather than having fallen into taking that risk accidentally through chasing dividends. Either way, investors must understand that the increased return is compensation for risk, not a direct outcome of the dividend policy of the business. On the other hand, dividends may be high not because the shares are risky, but simply because growth prospects are low.

Rational firms with low growth prospects often distribute dividends, as there are few good uses for the profits if reinvested in the business. These firms would not expect any increase in returns as a result of their high dividend yields. International Evidence Sorting shares by dividend yield in the US does not produce significant differences in average returns. This may suggest that a higher dividend yield results from a combination of a higher required return and a lower expected growth rate.

Sorting by dividend yield does correlate with higher returns in international markets, similar to the sorting of shares by other measures such as book value and earnings. Again, the dividends, reinvested, more than offset the loss from a falling share price.

Income Tax : AY 17-18 : Taxation of Dividend : Lecture 1

T is a shining example from the telecom utilities. The above examples show the mighty power of compounding thanks to reinvested dividends.

And there are many other stocks where dividends more than offset a stock price, which fell or rose just too little. It never paid a dime in dividends. Yet, in the last decade, it returned So obviously, it all comes down to the quality of the underlying stock. There are great returns to be made with or without using dividends. Important limitations and factors to consider There are multiple issues to consider before jumping to the conclusion that easy money can be made without any risk, and several caveats when using this specific strategy: In the real world, it is hard to predict or find investments that will have a total return over a long period of time consisting only of the dividend yield and zero capital appreciation.

So, investors should just try to seek out stocks that generate at least most of the total return via dividends. An obvious conclusion would be to invest in stocks with very high dividend yields, even though these might actually lose value in terms of capital appreciation thanks to falling price.

These stocks might have a higher risk profile, due to the dividend being suspiciously high, and the risk of their bankruptcy total loss of capital could be higher.

So, it is important that investors stick to their basic investing principles, such as "return of capital before return on capital. Further investigation is needed to determine whether this phenomenon is already priced in the current values of stocks. In other words, whether stocks of equal intrinsic value, but higher dividend yields, fall proportionally more in price, other things being equal, which would in effect negate partially or completely the benefits of higher returns realized through dividends as opposed to capital appreciation, because such stocks would lose more in capital than stocks with lower dividend payments.

Tax issues definitely have to be considered for each individual investor. Capital appreciation, as well as dividend payments, may or may not trigger different tax events at different tax rates, depending on what type of the investment account or vehicle is used and subject to the individual situation of each investor.

What Is More Valuable? Dividend Yield, Or Capital Appreciation? | Seeking Alpha

In Europe, the situation is different, because stocks often pay out dividends only once or twice per year. So, the compounding effect of dividend payments is not so profound over capital appreciation, or it is non-existent in the case of annual dividend payments.

On the other hand, in the case of monthly paying dividend stocks, the positive effect of dividends over capital appreciation is even more profound.

These generate, on average, an extra 5.

dividend yield and capital gains relationship

There are many other factors to consider, including trading fees in some cases of dividend reinvesting, etc.