LEVEL: BEGINNER
When building up a profile of valuable stocks, a lot of amateur investors focus on share price. Some potential investors are even turned off to equities entirely, after they notice that the prices of some shares have stayed relatively consistent over a very long period of time. Someone who bought AT&T in June 2008 paid $36.67 would notice that those stocks can be bought four years later for…$36.81. Such returns seem unimpressive, and a lot of investors are turned off to investing in some of the safest and best yielding securities for this very reason.
To understand the value of stocks when choosing which to put in your portfolio, you need to look past the price of the stock and consider the total return. This is easier said than done. When you look at a stock’s price history on major finance sites like Yahoo and Google, you are getting less information than you might think.
Verizon has done extremely well over the past year, with a steady upward price movement and an appreciation of 23.56% over the past year with an 8.39 point jump in share price. In other words, 100 shares bought a year ago for $35.63 per share (an initial investment of $3,563, excluding commissions) would now be worth $4,402 (again, excluding commissions). Not bad for a non-diversified large-cap bet.
However, in reality the return on this investment is even better. Note that Verizon pays out a quarterly dividend of 50 cents every three months. That $2 per share per year income is an additional income over and above capital appreciation, and makes Verizon a better performer than it appears at first glance. The company’s dividend represents a 5.61% yield on last year’s purchasing price, and means that the investor has actually received a profit of $1,039 over the past year in capital gains (the 8.39 appreciation times 100 shares) and in dividends (50 cents times 100 shares times four payouts annually).
Total Return refers to the combined return on a stock from both dividends and increase in share price. When we combine these two, we get a very different view of a stock. Looking at Verizon over the past ten years, the shares have gone up in price by 31%. If we look at the total return of the stock, we see that the shares have yielded 122.6% in gains from both capital returns and dividends.
When casual investors look at the stock market, they too often focus on price differences.
Headlines about the Dow Jones Industrial Average refer to the price of the stocks that make up the index, such as recent news that the index broke 13,000 points. While these make simple, easy-to-digest news stories for casual consumers, it is less revealing than the total return. For instance, the past 5 years have been terrible for the Dow Jones thanks to the 2008 crash; the index is up only 194.49 points from August 2007, or 1.49%. But if we add dividends to calculate the total return for the index, we see that it’s returned about 15.1% over the past 5 years. While not great, that’s still much better than the virtual flat performance that the price seems to tell you, and that journalists keep mentioning in the popular press.
People who don’t understand the power of dividends and the hidden value in dividend-yielding stocks will often point to crashes in equity values as evidence that it’s a racket, but a closer look demonstrates that consistent investment in stocks can yield good returns thanks to the dividends that companies pay. To understand the real value of these stocks, investors need to look at the total return instead of just the price.