Beware of Moving Targets
The last 12 months has been a bad time in the markets. Very few stocks have avoided the market-wide sell-off. And for a lot of stocks, as a result of their share prices being depressed, one measure of value – dividend yield – could be misleading.
The dividend yield is calculated by dividing the dividends paid per share over the course of a year by the stock’s price – and this number is of paramount importance to income investors. Oftentimes, there is a minimum yield that they are willing to accept when they invest in a stock.
And this is where the current markets could send you down the wrong path. Let’s take DuPont (DD), for example. For the past three years, DuPont has traded in a range from around $40/share to $50/share. During this period, it has paid a consistent dividend between $0.37 and $0.41. That would give investors a dividend yield between 2.9 percent and 3.7 percent.
A nice return, but perhaps too low to hit the radar screens of many income investors.
But now let’s look DuPont’s dividend yield today: 6.2 percent.
Your first assumption might be that the company has really fattened up its dividend. But that would be incorrect. What has occurred is that the stock price has fallen so much that the yield has been “artificially” driven up.
DuPont is now trading for around $26/share – about half of what it was even three months ago. This means the denominator in the equation for calculating dividend yield is much lower… and that’s why DuPont’s yield is so high.
When the market moves back up and DuPont’s share price follows, its yield will plummet back down.
[Ed. Note: Finding fundamentally strong companies is a good way to prosper despite the market's condition. But you can also make money on companies that are ready to crumble. Learn how to spot the "red flag" signals that could predict (with as much as 92 percent certainty) when a company's stock is going to tank.]
Comments