Why is dividend yield a part of expected future returns

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Enzo IX
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Why is dividend yield a part of expected future returns

Post by Enzo IX » Thu Oct 18, 2018 9:36 pm

I was listening to a Mr. Bogle podcast and he was asked what his estimate of the next ten year average return would be. His estimate was to take the current market dividend yield at approximately 2% and add estimated company profit growth of 5% to achieve a long term forecast of 7% if P/E ratios stayed the same.

I can't recall where I have read this way of estimating future returns, it was probably in one of his books I read a longtime ago.

My question is why do you think dividend yield is part of the equation for future expected returns. Its just a return of retained earnings coming out of cash position of the company.

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FiveK
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Re: Why is dividend yield a part of expected future returns

Post by FiveK » Thu Oct 18, 2018 9:55 pm

Enzo IX wrote:
Thu Oct 18, 2018 9:36 pm
I was listening to a Mr. Bogle podcast and he was asked what his estimate of the next ten year average return would be. His estimate was to take the current market dividend yield at approximately 2% and add estimated company profit growth of 5% to achieve a long term forecast of 7% if P/E ratios stayed the same.

I can't recall where I have read this way of estimating future returns, it was probably in one of his books I read a longtime ago.

My question is why do you think dividend yield is part of the equation for future expected returns. Its just a return of retained earnings coming out of cash position of the company.
Presumably companies have enough free cash flow to pay dividends at the current rate, even with zero profit growth. Add estimated company profit growth to current market dividend yield to get estimated return. Yes, the last sentence is a restatement of a quoted one but perhaps the altered perspective is helpful.

TJSI
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Re: Why is dividend yield a part of expected future returns

Post by TJSI » Thu Oct 18, 2018 10:02 pm

At all times, the value of your investment is equal to the number of shares you own times the price of each share. The rate at which you shares increase is the dividend yield. So it is one component of your return. Price increase is the other component of your return.

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Enzo IX
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Re: Why is dividend yield a part of expected future returns

Post by Enzo IX » Thu Oct 18, 2018 10:35 pm

But in all these dividend threads, isn't it agreed that the share price of the stock goes down by the amount of the dividend leaving a net zero gain? I guess I'm still confused.

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FiveK
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Re: Why is dividend yield a part of expected future returns

Post by FiveK » Thu Oct 18, 2018 10:53 pm

At the risk of more confusion, see the entry including Income plus capital gains equals total return.

bberris
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Re: Why is dividend yield a part of expected future returns

Post by bberris » Fri Oct 19, 2018 6:29 am

Enzo IX wrote:
Thu Oct 18, 2018 10:35 pm
But in all these dividend threads, isn't it agreed that the share price of the stock goes down by the amount of the dividend leaving a net zero gain? I guess I'm still confused.
Right. So if no dividend was paid, what would have been the dividend would appear as a price/value increase. The point is that cash returned to shareholders, whether you sell stock or get paid a dividend, does not matter in an efficient market. There is no reason to ignore a return that is paid as a dividend. There is no reason to say a price increase or decrease does not affect your return.

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JoMoney
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Re: Why is dividend yield a part of expected future returns

Post by JoMoney » Fri Oct 19, 2018 6:50 am

The value of the stock may go down when a cash dividend is paid, but excess cash sitting on the balance sheets reduces the 'Return On Equity' of the company. Investors usually want companies/stocks that can grow at some reasonable rate, nobody wants to pay a dollar for a dollar sitting on the corporate balance sheets, especially not at 3x book value... which would be more like paying $3 for $1 (but the market is likely already discounting the lower expected return on cash balance)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Ron Scott
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Re: Why is dividend yield a part of expected future returns

Post by Ron Scott » Fri Oct 19, 2018 7:22 am

FiveK wrote:
Thu Oct 18, 2018 9:55 pm
Add estimated company profit growth to current market dividend yield to get estimated return.
Yes, over the long term this is all you get.

Historically, the average earnings of the S&P500 has been between 5-6% with dividends ranging between 2-3%. Add those two together and that is what you got for a long term return in the stock market, 7-9%. But the market swings wildly because of a third factor: speculation. Pesky investors get in the mix and drive prices up and down based on the craziness of human nature which tricks us into thinking we can predict future earnings, and s the theorists say “the change in value that comes from what investors will pay for a dollar of earnings.”
Last edited by Ron Scott on Fri Oct 19, 2018 7:28 am, edited 1 time in total.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Why is dividend yield a part of expected future returns

Post by Ron Scott » Fri Oct 19, 2018 7:22 am

Double
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Enzo IX
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Re: Why is dividend yield a part of expected future returns

Post by Enzo IX » Fri Oct 19, 2018 12:14 pm

I realize that total return is made up of two parts, dividend distribution and share price appreciation

I guess my confusion is if return over the long run is based on overall profit growth of the company since it seems the main measure Wall Street uses to value a company is P/E ratios. What does a dividend distribution have to do with the profitabliity of the company.


If Company "A" doesn't pay a dividend does that mean it has a lower expected future return than Company "B" that pays a 3% annual dividend.

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Enzo IX
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Re: Why is dividend yield a part of expected future returns

Post by Enzo IX » Fri Oct 19, 2018 12:20 pm

I'm not trying to be argumentative because I know I'm wrong. Just one of those things that I don't understand. Need to really dumb it down for me.

Wakefield1
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Re: Why is dividend yield a part of expected future returns

Post by Wakefield1 » Fri Oct 19, 2018 12:27 pm

Enzo IX wrote:
Thu Oct 18, 2018 10:35 pm
But in all these dividend threads, isn't it agreed that the share price of the stock goes down by the amount of the dividend leaving a net zero gain? I guess I'm still confused.
What about the analogy of milking a cow-after you milk it the cow weighs less and can't be immediately milked again-but the next day it has regained the lost weight and ready to be milked again-(if it is a healthy cow)
healthy company with earnings supporting the dividend?

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FiveK
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Re: Why is dividend yield a part of expected future returns

Post by FiveK » Fri Oct 19, 2018 12:30 pm

Enzo IX wrote:
Fri Oct 19, 2018 12:14 pm
If Company "A" doesn't pay a dividend does that mean it has a lower expected future return than Company "B" that pays a 3% annual dividend.
Not necessarily, because dividend rate is only one part of expected return. What are you assuming for the profit growth of companies A & B?

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Re: Why is dividend yield a part of expected future returns

Post by Wakefield1 » Fri Oct 19, 2018 12:32 pm

Enzo IX wrote:
Fri Oct 19, 2018 12:14 pm
I realize that total return is made up of two parts, dividend distribution and share price appreciation

I guess my confusion is if return over the long run is based on overall profit growth of the company since it seems the main measure Wall Street uses to value a company is P/E ratios. What does a dividend distribution have to do with the profitabliity of the company.


If Company "A" doesn't pay a dividend does that mean it has a lower expected future return than Company "B" that pays a 3% annual dividend. [[ Suppose the Market believes Company "A" will pay a bigger dividend stream in the future? ]]
Suppose Company "A" has higher profits than Company "B" but chooses for the time being to reinvest or retain or spend those profits on R and D

alex_686
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Re: Why is dividend yield a part of expected future returns

Post by alex_686 » Fri Oct 19, 2018 1:40 pm

As a counter example I will point towards REITs, where the majority of return comes from dividends, not capital apperiations.

The real answer is that Total Return Calculations are a generic calculation designed to handled dividend paying stocks, non-dividend paying stocks, REITs, real estate, bonds, etc.

By the way, TR calculations assume you reinvest any cashflow, like dividends, back into the investment.

There are calculations that require you to split out the dividends from the earnings, like the Dividend Discount Model - but that is not for calculating returns.

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vineviz
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Re: Why is dividend yield a part of expected future returns

Post by vineviz » Fri Oct 19, 2018 2:03 pm

Enzo IX wrote:
Fri Oct 19, 2018 12:14 pm
I realize that total return is made up of two parts, dividend distribution and share price appreciation

I guess my confusion is if return over the long run is based on overall profit growth of the company since it seems the main measure Wall Street uses to value a company is P/E ratios. What does a dividend distribution have to do with the profitabliity of the company.


If Company "A" doesn't pay a dividend does that mean it has a lower expected future return than Company "B" that pays a 3% annual dividend.
That’s basically it.

Once earned, a company has two possible uses for a dollar: it can invest it back into the business, with the hope of increasing future earnings via positive ROI, or it can return directly to the share owner (in the form of dividends or share buybacks)..

Under certain reasonable assumptions, it makes no difference to the share owner.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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