Learning to calculate the dividend yield of a stock or security and comparing it to the yield of available government securities is the fundamental principal investment.
Dividend yield is calculating by: Dividend yield = (Dividend per share * 100) / (Price of Share)
Chevron (CVX) data as of 1/17: Dividend per share = $4, Price of share = $119.29
(4*100)/119.29 = 3.35%
Chevron has a dividend yield of 3.35%
Benjamin Graham placed a lot of emphasis on the dividend rates that a company pays and the consistency of payments. One concern for an investor of dividends is that if management can continue to put the money to good use earning an above average return on equity then people like Warren Buffett believe they should do so. Berkshire Hathaway has never paid a dividend and its investors benefit. Dividends can be nice for bigger businesses that have limited capital needs but it’s often better if a company can deploy it in other ways and continue to return a higher return. For this reason Buffett would suggest you also look the earnings yield, or in his case the owner’s earnings yield.
In our example, we worked out the dividend yield on shares for Chevron is 3.35%. At the time of rating the 10 year US Treasury Bills are yielding a rate of 2.82%. The dividend yield of Chevron is obviously slightly above this. If all things were equal we’d be done here.
But, we must consider
- Whether or not interest rates are likely to rise? I know we’ve said you should never speculate and we don’t but there’s often some simplistic analysis you can do here. Today the rate is 2.82% but the prime rate is a mere 0.25%. There is very little room for rates to go down further. When bond rates rise, existing bonds prices fall to compensate and this results in a loss of capital if you have to sell before the 10 year maturity.
- The potential that the earnings of the company will grow. In our example Chevron is trading at a very low 9.76 Price to Earnings ratio which implies a very low expectation of growth. While the price of oil and a host of other things can make this more complex. Chevron seems very reasonably priced to avoid losses.
- The risk of economic deterioration The US 10 year treasury is considered safe and has no real risk of default. Most companies can watch their earnings drop off a cliff. In that scenario the Treasury would be better.
- The risk of inflation Economic decline is the kryptonite of stocks (some exceptions may be things like Utilities which will remain relatively constant) and Inflation is the kryptonite of bonds as you will watch your buying power erode quicker. Commodities like oil and companies that sell the goods can raise prices and often quicker than salaries go up while bonds are caught naked. This is the hidden risk of “risk free government bonds”