The Stock Market’s Dividend Yield
This fundamental measurement tells us a lot about valuation.
On page 25 of The Neatest Little Guide to Stock Market Investing, you learn the following:
The annoying thing about stock measurements is that even if every one of them gives a green light to a stock you’re considering, it might still end up being a bad investment. It’s not like measuring your inseam. Once you know that number, you know the length of pants to buy and if they’re that length, they fit. Period. It’s not that simple with stocks.
Nonetheless, knowing how your stocks measure up is important. Knowing something that might make a difference is better than knowing nothing at all. In most cases, the measurements do reveal valuable information.From there, the book presents a number of fundamental stock measurements, including dividend yield. Let’s pull from the book some of the basics about dividend yield, then we’ll see how today’s market stacks up by this metric.
Definition of Dividend Yield
From page 27 of The Neatest Little Guide to Stock Market Investing:
A stock’s dividend yield is its annual cash dividend divided by its current price. If Mister Magazine paid a quarterly dividend of $.15, you assume that its annual dividend is $.60—15 cents per quarter times four quarters in a year give you 60 cents. Let’s say its current stock price is $15. Divide .60 by 15 to get a yield of .04 or 4 percent. It’s simple to figure a stock’s dividend yield, but you won’t need to do it. It’s printed for you in the newspaper every day, and displayed constantly online.
At first, dividend yield probably looks pretty boring. A lot of stocks don’t pay dividends anyway, and who really cares what a stock yields in dividends? If you want steady payouts, you’ll go to your local bank.
But alas, amigo, the dividend yield reveals plenty about a stock’s price. It tells you more about a stock’s price than it does about a stock’s dividend. Why? Because there are only two numbers involved in the dividend yield. If one number remains constant then the other number drives any changes. With most companies, the dividend payout remains fairly constant. That leaves you with only one other number to influence dividend yield: stock price. It changes daily and its relationship to the dividend is immediately reflected in the dividend yield.
Look what happens. If Mister Magazine’s price rises from $15 to $30 but it maintains a constant dividend of $.60, its dividend yield drops to 2 percent. If the price then rises to $60, the dividend yield drops to 1 percent. If the dividend remains constant and the yield changes, you know the price is moving. In this case, Mister Magazine’s decreasing yield tells you that the stock price is rising and might be overvalued.
The Market’s Dividend Yield
Dividend yield is not just for individual stocks. The entire market also has a dividend yield revealing similar information. Just as we can see whether an individual stock is richly or cheaply valued by its dividend yield, so we can get a glimpse of the aggregate market’s status.
Here’s how it works.
Rather than looking at one company’s stock price and dividend, as in the above Mister Magazine example from the book, we can average together the prices of a group of stocks, or index, and average its combined dividend payouts, to ascertain the dividend yield of the group. Then we can compare today’s figure to last month’s, last year’s, and farther back to see whether the group is cheaper or more expensive than usual by this measurement.
Let’s go find a group of stocks to check.
The S&P 500 via SPY
The most widely followed index representing the US stock market is the S&P 500, a group of 500 large US stocks, weighted by market capitalization, or market cap. That, by the way, is the size of a company in the market. From page 40:
Market cap is determined by multiplying the number of outstanding shares of stock by the current market price per share. So if Mister Magazine has grown like Jack’s beanstalk and there are 4 million shares of its stock outstanding and they trade for $10 per share, Mister Magazine’s market cap is $40 million.
Is that big or small? Compared to the treehouse operation it started as, that’s huge! From its $1,000 initial sale to venture capitalists, Mister Magazine has grown 3,999,900 percent. So from an initial investor and company founder perspective, Mister Magazine is enormous.
But compared to Exxon Mobil, it’s a drop of oil in a tanker. Exxon’s market cap was about $420 billion in January 2012. That’s 10,500 times bigger than Mister Magazine. As you can imagine, owning shares of Exxon and owning shares of Mister Magazine would probably be very different investment experiences.
Today, Exxon’s market cap is $542 billion, and the average market cap among all S&P 500 companies is $92 billion. As of yesterday’s closing prices, the following were the ten biggest American companies by market cap:
You can own the entire S&P 500 with the SPDR S&P 500 exchange-traded fund (ETF), symbol SPY. It’s managed by State Street Global Advisors (SSGA), headquartered in Boston, Massachusetts, and is actually the very first ETF and still the largest in the world by assets under management: $580 billion as of this writing. SSGA invented the ETF investment vehicle with the launch of SPY in 1993, and remains a top participant in the industry: it’s the number three ETF manager in the world, after BlackRock and Vanguard. Here’s its iconic building, at 1 Congress Street in Boston:
S&P 500 Dividend Yield
Add up the 12-month dividends of all S&P 500 companies and divide by the index level, and you’ll get a current dividend yield of about 1.25 percent. That’s down from 1.32 percent in June, the end of the second quarter, which is the most recent earnings period on record. Third-quarter earnings will start being reported soon.
Why is the yield lower now than in June? Due to the basic math of dividend yield. With dividends staying fairly steady, price—or in the case of an index, level—drives the yield change. If the yield is lower now than in June, can you guess the direction of the S&P 500 since then? That’s right—up. Have a look:
Notice that you’ll get the same chart with SPY, as you would expect because it tracks the S&P 500:
As the S&P 500 rose 6.1 percent from 5,460 at the end of June to 5,792 now—and SPY’s price rose 6.1 percent from $544.22 to $577.14 now—the index’s dividend yield declined from 1.32 percent to 1.25 percent. It is literally more expensive now, and by this measurement looks more richly valued.
But does this tell us anything about the market’s future direction? Not really.
Valuation is an Unreliable Forecaster
Gut instinct might tell you that, because the market is up, you should wait until it comes down before timing your entry. The problem with this is that the market rises more than twice as often as it falls. Stocks are usually heading higher, and it’s quite possible—likely, even—that from a high valuation, they will proceed even higher.
Let’s go through some market history. The following table from YCharts shows quarterly dividend yields for the S&P 500 back to March 2012:
What we find when digging into this and comparing market change after certain yields appeared, is that sometimes a higher yield indicated a good time to buy stocks, but sometimes it didn’t, and vice versa on avoiding stocks.
For example, the S&P 500 declined 14 percent in the fourth quarter of 2018 in what was nicknamed the “tech wreck” of that year, because the crash was led by tech stocks. Notice that the decline pushed the S&P 500’s yield up from 1.80 percent in September 2018 to 2.14% in December 2018. That indicated a better bargain to be had, and was a fine buy signal. Here’s how the index performed after it:
S&P 500 Returns
After Q4 2018 (%)
– – – – – – – – – – – – – – –
13.0 in 3 months
17.4 in 6 months
28.9 in 12 months
Pretty darned good.
Then your eyes wander to that tantalizing 2.31% dividend yield at the end of March 2020. You know that was the bottom of the covid crash and one of the best times to have bought stocks in recent years. Then you see that the dividend yield fell to 1.27 percent at the end of December 2021, just before the bear market of 2022.
It’s tempting to think, By golly, dividend yield really does work. And it does, sort of, but we’re not done yet.
Notice that, from a high of 2.19 percent in December 2012, it fell to a low of 1.91 percent in June 2014. Was that a good time to have avoided stocks? No. The S&P 500 rose 2.2% in two months, and 7.4% in eight months.
Conversely, was the high dividend yield of 2.21 percent in September 2015 a good time to have bought? Not especially. The S&P 500 was flat over the next five months. It did rise 12.9% over the next 12 months but, remember, stocks usually rise.
About the best we can say about dividend yield for timing purposes is that it helps sometimes, but we can say that about almost every forecasting tool and even then it’s hard not to wonder about coincidence. Constantly say stocks will rise and you’ll be right two-thirds of the time.
But most important, in the above examples, did dividend yield tell you anything that price didn’t already tell you? Not really. After the tech wreck in the fourth quarter of 2018, you didn’t need to look at anything other than price to identify a good entry point. If we determine that price down equals dividend yield up, can’t we just stop our analysis at the price down part? Basically, yes.
With that, you begin to see why I eventually converged on price change as the only input to inform the quarterly signals of my plans. But that’s a discussion for a different day.
Today’s takeaway is that, like all fundamental metrics, dividend yield is a decent but unreliable indicator for timing purposes. If your own timing is right for investing, such as after receiving a windfall of some sort, and you also see that dividend yield is high compared with its historical trend, then you can derive some comfort in that bit of serendipity.
If you’d like to read more by me on the limits of valuation measurements in forecasting, please see my February 2024 Signalizer installment, Valuation: The Broken Barometer—It’s a pro at dodging bull markets.