Dividend yield

CFA Level II Equities
#1

Hi guys,

I am blocked on the following: dividend yield is negatively related to growth rate in dividends.

My reasoning would be that a higher growth rate in dividends will increase dividends but at the same time reduce stock price. Since the impact is bigger on the dividend than it is on the stock price, the dividend yield should go up. Thus, to me, dividend yield is positively related to earnings yield. I can see that there is a negative sign when calculating the justified dividend yield leading us to conclude that the dividends yield should be, on the contrary, negatively related to growth rate in dividends.

Could somebody clarify that?

#2

As the growth rate in dividends increases, the stock price increases, but the current dividend remains unchanged; thus, the dividend yield decreases.

For example, given:

  • D0 = $1.50
  • g = 2%
  • rCE = 8%

We calculate a stock price of:

P0 = D1 / (rCE – g) = $1.50(1.02) / (8% – 2%) = $25.50

The dividend yield is:

$1.50 / $25.50 = 5.88%.

If the growth rate increases to 3%, then the stock price increases to:

P0 = D1 / (rCE – g) = $1.50(1.03) / (8% – 3%) = $30.90

The dividend yield in this case is:

$1.50 / $30.90 = 4.85%.

#3

here, the dividend is thus static data and the price (justified price) is derived from GGM which can fluctuate according to changes in assumptions regarding growth and required return correct?

#4

Yup.

#5

thanks for the details!!! Great job!

#6

My pleasure.

By the way, I wrote an article on justified ratios that may be of some help: http://financialexamhelp123.com/justified-ratios-price-multiples/.

#7

Great brief overview! Especially, the explanation referring to “higher payout ratio, higher leading P/E ratio” is helpful—article is really recommendable.

#8

I appreciate it.

Thanks.