UNITED STATES—Everyone considering investing in a publicly traded company is likely familiar with the term – corporate action. It signifies an event brought upon via a decision of a business entity’s board of directors and may get authorized by its shareholders with sizable ramifications on the company’s future.
A dividend is one of the more popular corporate actions regarding equities securities. That is so because this phrase gets bandied about quite frequently and is something that even non-financially savvy individuals have heard of and understand as a concept. In mathematics, it signifies a number that will get divided by another one. Yet, in the corporate world, it is a sum of money paid from a company’s profits/reserves, usually annually, to its shareholders. It is a reward for those that own shares, a prize for investing in the business and facilitating its growth.
Sizeable dividend payouts are signs of healthy cash generation and always get welcome. The dividend yield is the ratio that aids investors in uncovering the level of return they are getting for their stake. Some of the more famous players in the US financial sphere with impressive dividend yields include Verizon Communications (5%), Pioneer Natural Resources Co (4.4%), and Exxon Mobil (3.6%). For illustration purposes, the latter company paid $3.8 billion in one quarter of 2022 in cash dividends, proving how lucrative investing in it can be. It must be said that no firm has a legal obligation to pay out dividends, as it can select to channel its generated funds back into the company.
Most people are unaware that aside from cash and stock dividends, scrip, property, and liquidating ones exist. On top of these, when it comes to projections, trailing and forward dividends are things to consider when investing. StockMarketEye.com provides some easy-to-understand examples of how trailing vs. forward dividends pay, and how these two evaluation criteria stack up gets explained below.
What Dividends Mean to Investors
By looking at these figures, investors can try to judge what they can hope to earn by owning a piece of a company. It sets their expectations in order. Still, a company’s profits will depend mainly on the execution of its business model, the sector’s general economic standing, and the global economic environment. Turning a profit in one year does not mean that this occurrence is probable to get repeated in the following one. Still, if an entity’s profits have been lowering for long enough, that is indicative that its board may select to eliminate dividends altogether.
What Is a Good Dividend Yield?
The established train of thought is that yields between 2% and 5% are more than acceptable. Stocks with ones below 2% may not give investors enough current income, and those above 5% may indicate a risky trade. Risk refers to, in the worst-case scenario, a dividend that becomes susceptible to getting reduced dramatically in the not-so-distant future. But usually, it means the company’s dividend rate per share does not increase in the years to come.
As a rule of thumb, this is the percentage of income an investor’s portfolio has returned over the past twelve months. The term trailing comes from a word used in economic sciences to describe a data series, a property of measurement, and an indicator that reflects past events or observations, often within a specific interval, like the yearly one. Trailing data gets primarily utilized to uncover underlying trends and pinpoint turning points. It is a metric that is handy in smoothing out short-term random noise and helps investors make better decisions.
The dividend yield for funds and stocks is calculated by dividing the security’s total dollar amount paid to shareholders as income by the market share price. For mutual funds, note that the dollar income value also features fixed-income securities’ interest income from realized gains from currency transactions and stock dividends.
In general, sums for the past year get added together to reach the total dividend payout. Quarterly trailing dividends get calculated by adding up share price from four monthly dividend payouts using months that are spread apart, like February, May, August, and November. Not concurrent ones, such as January, February, March, and April.
The Pros & Cons of Trailing Dividends
The gambler’s fallacy is the idea that past results dictate future outcomes. That is inaccurate in gambling and life and is something to keep in mind when investing in growing companies that seek to expand yearly. By the very nature of growth, each subsequent year should post more revenues than the previous. And hopefully, more profits. Nevertheless, that is not always so, and historical data paired with market research gives everyone a decent potential outlook on what things may look like relatively soon.
It is crucial not to look at trailing dividends as rock-solid projections but as signals, which, when blended with other measurements/gauges, can supply a decent yardstick of what one can expect going forward.
A forward dividend is an estimation of a company’s annual dividend, nothing more. It gets calculated by taking a stock’s most recent yearly dividend payment and then annualizing it. So, if an asset has paid a quarter-one dividend of $0.25, and if the assumption is that it shall remain stable for the foreseeable future, then the expectation is that, over the year, it shall pay a dividend of $1.00. That means that if the price of this security is $10, then 10% will figure for the annual forward dividend yield.
Essentially, this is the opposite of the trailing dividend yield. But, in most financial experts’ eyes, it is a far more accurate tool for investors to use when ascertaining potential ensuing gains.
When attempting to figure out the validity of forward dividend projections, individuals must factor if the company has a history of stable dividend payouts that would supply an adequate degree of comfort in projecting the current dividend forward. Plus, what is its policy concerning dividends? When do these get declared? The preference is that this gets done at the start of a calendar year.
Positives & Limitations of Forward Dividend Yield
As mentioned, many believe that forward dividends are more accurate than trailing estimations. Nonetheless, in some cases, like companies with unstable dividends, the latter can be more reliable, as calculating the forward dividend yield in these instances will often provide an inaccurate forecast.
Forward Dividend Yields & Corporate Dividend Policy
The board of directors is the body that chooses if a company will pay dividends and how it will do so. It is common practice for more established brands to select to issue this corporate action to shareholders. Start-ups focus on growing, gathering all excess money, and funneling it back to development and research. That is why it is paramount for investors to understand the type of entity they will get a share in and check out its policies before paying their piece.
The principal aim of a stable dividend policy is not to align with its quarterly earnings volatility but to maintain long-haul expansion expectations. When receiving a constant dividend payout, investors have a quality grasp of the volatility of the company’s earnings. And if an entity has a residual policy, it pays out earnings following settling working capital needs and expenditures. That is vital info to know for all investors.
Which Is Better – Trailing or Future Dividends?
Naturally, estimating forward dividends is an inexact exercise, while calculating trailing dividends can get done with precise accuracy. But what does that mean for investors? Not much. Moreover, in some firms, reward payouts can fluctuate depending on their business prospects, while others have exceptionally stable dividend policies. They pay identical sums quarterly. Experts tend to lean more toward future dividend yields, even though these are less reliable in multiple instances. Still, as a whole, data shows that they tend to be more accurate in predicting near-future success, despite trailing dividends having a more factual basis.
The Bottom Line
A trailing dividend yield is an estimation that uses factual/historical dividends per share paid out in the past years as a method/tool for forecasting future dividend yields. It is a measurement perfect for companies whose profits can vary sizably. Conversely, a future dividend yield is a projection that uses the most recent dividend per share when figuring out the next quarterly/annual dividends. It is the ideal adviser for companies with a clearly-defined dividend policy, where it gets started when they announce payouts and ones with a track record of producing stable dividends.
Know that the forward dividend yield does not always determine if an investment is worth considering. A higher one may indicate a drop in the stock’s price, which can happen due to a setback such as bankruptcy. Also, remember that the more dividends a company pays out, the less money it is reinvesting in its expansion. It restricts its possibilities for growth when things are going well. So, no one should use divided payments as their chief barometers when deciding if they should invest in a corporate entity.