11 Minute Read

Options Theory: Dividends and Stock Selection

December 2, 2021

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Stocks pay investors in two ways: price appreciation and dividends. Ultimately, I don’t really care which way the gains come, provided they come!

Let’s look at an example using the biggest stock of them all: Apple.

AAPL stock entered 2021 at $132.62. As of Wednesday, it was trading for $170 for a price gain of $37.38. That translates into a 28.2% increase.

Price return: 28.2%

But the company also pays a quarterly dividend. Here were the four payments this year: 20.5 cents, 22 cents, 22 cents, 22 cents. All in, that’s 86.5 cents per share.

Dividend return: 86.5 cents / $132.62 = 0.65%

Adding both the price and dividend together creates what’s known as the total return: 28.85%

In this example, the dividend played a very small role in investors’ year-to-date returns. Imagine someone avoided buying AAPL because of its puny 0.65% dividend yield heading into 2021. Because they overemphasized the role of the dividend in the total returns, they missed out on the monstrous overall gain of 28.85%.

Point One: Focus on TOTAL return, not just dividends.

Though the dividends didn’t move the needle for Apple this year, it doesn’t mean that’s always the case. In some instances, it seems dividends are the only way investors get paid. Take Verizon, for instance.

Verizon Case Study

Suppose you bought VZ stock in July 2018 for $51. Here we are three years later, and the stock is back at $51.

Price return: 0%

Your price return is zero. But, as a telecom stock with a historically high dividend payout, you have been receiving quarterly checks – 14, in fact. They add up to $8.61 of income.

Dividend return: $8.61 / $51 = 16.9%, or approximately 5.6% per year.

While the dividend was a mere afterthought for Apple, it was your sole source of reward for Verizon, which made it essential.

Point Two: Dividends do the heavy lifting in delivering gains for certain stocks.

Desirable Dividend Yield Range

Here’s a question I received:

Tyler, do you prefer stocks that pay dividends. If so, what dividend yield range do you look for?

This question is geared toward buying and holding for the long-term. Dividends don’t enter the equation when it comes to short-term trading for reasons that I hope are obvious. My short answer to the query was that I don’t necessarily prefer stocks that pay dividends. It’s altogether more important that I like the company’s fundamentals and long-term prospects. Admittedly, I mostly use ETFs to get the diversification.

As shown in the Apple versus Verizon examples, total return matters far more than dividend yield. At 0.65%, Apple’s dividend yield was almost one-tenth the value of Verizon’s. And yet, Apple delivered a far better reward.

Those that focus too much on yields are missing a huge part of the equation. What’s more, sometimes the dividend yield can be deceiving. Stocks with abnormally high yields are actually less attractive, not more. They are usually a byproduct of the stock price getting destroyed because of something fundamentally amiss with the company.

Take AT&T, for instance. It boasts a 9.25% dividend yield right now.

Sounds sexy, right? Here’s the price chart:

Is that really a stock you want to own?

Point Three: Beware stocks with abnormally high dividend yields.

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