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Suppose a stock is at $10, and it is giving out $0.50 dividend, which is 5%, and you bought it.

Then a couple of years later, it rose to $20, and is giving out 5% dividend, which is $1.00, but to you, it is like a 10% dividend, because you only put $10 in.

Then a couple, or 3 to 4 years later, it rose to $40, and is giving out 5% dividend, which is $2.00, but to you, it is like a 20% dividend, again because you only put $10 in.

At this point, if 20% is something that you'd be satisfied, should you consider it a 20% dividend stock, and never sell it for the rest of your life as long as it is $40 or higher and giving out 5% dividend? Or is this idea flawed, because you could easily move the money to another stock that gives out 5% and it is the same absolute dollar amount.

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  • aka "yield on cost" – Chris W. Rea Feb 4 at 13:29
  • @ChrisW.Rea don't answer questions in the Comment section!!!!! – RonJohn Feb 4 at 15:03
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    Just for clarity, dividends are not decided as a % of the share price (this is something investors may compute to evaluate the performance of a stock, but the % is the result, not the starting point. Dividends are usually (very vaguely) related to the profits of the company. The share price could go up 1700% or down 80% for whatever reason completely unrelated to the profits or the dividends. It would be logical for the share price to follow the dividends (note the order), but logic and financial markets are not always friends. – jcaron Feb 4 at 16:38
  • @jcaron Actually, I think dividends are usually (very vaguely) more related to the cash flow of a company, not the profits. For example, take a look at Royal Dutch Shell (RDS A/B) right now. They are raising dividends even though they are not currently profitable. – RockPaperLz- Mask it or Casket Feb 4 at 22:58
  • @RockPaperLz-MaskitorCasket isn't it true that they can take in a lot cash, but due to real estate or land or whatever they bought earlier, they can "depreciate it", making it "depreciation cost" and therefore, the income is low or even 0, and they don't have to pay tax. The net income is 0 or negative. But in fact they did take in a lot of cash – nonopolarity Feb 5 at 9:52
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The stock price appreciation is a "sunk gain" (analogous to a sunk cost). The relevant yield is 5% because the choice you have now is between the $2/year income stream and the $40 you'd get by selling it. Or to put it another way, if you reinvest the dividend, you have to do so at a price of $40, not $10. The original purchase price should play no role in decisions about an investment (with the possible exception of capital gains taxes).

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    Right, the choice you have today is to sell the share for $40 and invest that cash somewhere else, where 10% return would earn you $4, or you can keep the share of stock and earn $2. You definitely shouldn't think of the $2 as a 20% payout, since that's not calculated with respect to what the stock is worth right now. – Nuclear Hoagie Feb 4 at 17:03
  • so if the stock is in the 401k plan, then selling wouldn't be an issue for capital gain tax? – nonopolarity Feb 4 at 17:11
  • @nonopolarity: that is correct. In a 401k you only pay tax when you take the money out, not on gains along the way. That, aside from any matching you get, is what makes 401k plans so nice. – Ross Millikan Feb 4 at 20:09
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Company don't usually follow dividend yield, but payout ratio. It doesn't matter if the price is going up and down, if the net income is stagnant, the dividend will also be stagnant.

But, to address your hypothetical question, if the current price is $40, and the dividend is $2, then the relevant yield is 5%, because, if you sell your stock for $40, then buy another stock with same yield, at the same price, you'll get $2 for $40, and it's 5%.

To put it simply, your stock is now $40 with $2 dividend. There is another $40 stock with $4 dividend.

You'll gain more money if you sell your current stock to buy the 10% yield stock. So your current stock's yield is not 20%.

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It's a nice hypothetical position to be in but companies don't double their dividend every few years.

If non sheltered, it would make no sense to sell the stock for $40 in order to buy another stock with the same yield because there would be a large capital gains tax, reducing your compounding. It's better to defer that.

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    I think you got hung up on the "doubling". That's just simplifying the math, but the same logic applies if the dividend is 3.6% and the price increase is 17% in 4 years. Tax issues can be real, but will vary between jurisdictions. If that $ is a USD, then capital gain tax is a valid concern. – MSalters Feb 4 at 14:27
  • Is it important to figure out what you will do in an unrealistic make believe hypothetical that doesn't occur in the stock market? Or can you name a company that has consistently raised dividends, quadrupling them over "several years"? – Bob Baerker Feb 4 at 15:29
  • so if the stock is in the 401k plan, then selling wouldn't be an issue for capital gain tax? – nonopolarity Feb 4 at 17:11
  • @MSalters Companies don't issue dividends based on stock price. The yield % fluctuates with the price. – JimmyJames Feb 4 at 20:21
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At this point, if 20% is something that you'd be satisfied, should you consider it a 20% dividend stock, and never sell it for the rest of your life as long as it is $40 or higher and giving out 5% dividend?

This is the issue. You have $40 stock with a $2 dividend. Your actual cost is meaningless when looking at these 2 numbers. Say, I found you a good $40 stock with a $2.50 dividend. Does the 20% figure help or hurt your calculations?

As Chris calls it "yield on cost", it's interesting to think of it this way, but not for sake of any comparison. As others will likely have a different cost.

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Imagine your shares went from $10 to $40. If you sell all your shares for $40 and then buy them back immediately for $40 then nothing has changed. But now, you would be calculating the $2 dividend as 5% of $40, and not as 20% of $10.

Or let's say in the original situation, you find another share that costs $40 but pays $4 dividend (10%). The way you calculate the dividend as 20%, your $2 dividend (20%) somehow manages to be better than the $4 dividend (10%). Clearly that can't be right.

Summary: You always calculate the dividend as a percentage of the current share price, not the share price when you bought the stock.

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