 # Div Yield Question

I’m getting a little confused with the implications of div yield on valuation - perhaps someone can explain. In one part of the Schweser notes, it states that a stock’s dividend yield is 'positively related to the required return, and negatively related to the forecasted growth in dividends. Therefore choosing high dividend stocks reflects a value rather than a growth investment strategy." This seems to contradict what is said elsewhere in the curriculum, where a higher dividend yield would lower the required return for a stock. Also, a higher dividend yield would imply a higher justified PE using the formula (1-b)/(r-g). So how can it be a value play?.. Thanks

Not sure where in the books it says dividend yield is positively related with required return. The divided yield lowering required return for a stock is based on the bird in the hand theory, that money now is better than money in the future - although this obviously depends on tax rates.

kurupt1 Wrote: ------------------------------------------------------- > Not sure where in the books it says dividend yield > is positively related with required return. > p243 of Schweser notes in Price Multiples chapter. I can see why a higher div yiled equals lower growth, but not so sure about why it should increase a firms required return? And I’m not sure why a high dividend paying stock should be a value stock, when its justified PE will be higher than a firm paying a lower dividend (all else equal)

I’m a bit rusty on Equity (starting to run through it again from today) but I think you’re confusing growth/value strategy with growth/value stocks. In terms of the dividend yield, you need to look at it the other way around, i.e. if dividend yield increases you would expect required rate of return to drop as well as movement in the price. but if required rate of return increases - and crucially, price remains the same - the dividend yield would increase.

Misk13 Wrote: ------------------------------------------------------- > states that a stock’s dividend yield is > 'positively related to the required return, and > negatively related to the forecasted growth in > dividends. Therefore choosing high dividend > stocks reflects a value rather than a growth > investment strategy." Justified (i.e. fundamentally forecasted) div yield formula: D(0) / P(0) = (r - g) / (1+ g) This formula makes it clear that as r increases, so does div yield (D/P). But as growth increases, div yield declines, all else equal. So maybe your question is how to intuit this. This is easy for growth: 1) The more the growth, the more valuable the company, the stock price increases. Existing dividend yield declines as this happens, as dividends tend not to increase as fast as the stock rises. (This is a practical point, not a fundamentals-driven point.) 2) The more the growth, the more need the company has to reinvest its earnings into the company instead of paying dividends. Indeed to maximize its growth opportunity, the company must do this to the extent it finds projects that yield over its WACC. For required return, the intuitiveness is more difficult, but building on point 2 for growth intuition, the higher the required return, the higher the WACC, the fewer projects that will meet the WACC bar, the more funds left over out of which dividends can be paid. > This seems to contradict what is said elsewhere in > the curriculum, where a higher dividend yield > would lower the required return for a stock. Actually no contradiction. If a company *decides* to hike its dividend, an investor won’t require as much in capital-gain return. This effect is heightened for the large investor community seeking dividend returns. The corp finance text discusses this effect (albeit more as an incentive for a company to *institiute* a dividend). > Also, a higher dividend yield would imply a higher > justified PE using the formula (1-b)/(r-g). So > how can it be a value play?.. It would increase P/E only if the cash used for the dividend was “idle” because it couldn’t be invested in projects returning in excess of the company’s WACC. If the cash instead took away from such projects, growth would decline and, which by the formula, would tend to lower the P/E. All this is consistent with the rest of our discussion, I’d say. Dividend stocks tend to be value stocks because their growth rates tend to be much lower than growth stocks, because growth stocks need all their cheapest capital (earnings) to plow back into their growth. HTH