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Evaluating equity yields

Can you please clarify the situation where a quoted company is listed as having a gross yield, a figure which varies so much from company to company? The yield appears to be as low as 0.60 for Kerry or Kingspan but as high as 11.7 for Unidare or 14.40 for Lamont. Do these figures mean that £1,000 (€1,270) invested in Kerry or Kingspan will return £6 per annum, while a similar amount in Unidare returns £17 per annum or in Lamont £44? For such returns, why should we invest in companies other than Unidare or Lamont?

J.P.L., Meath

The first thing to understand is what exactly gross yield is. More precisely, it is called gross dividend yield and it is, essentially, the dividend payable per share to the investor as a percentage of the share price.

For instance, take company A. It most recently paid a gross dividend of 10 cents to shareholders for every share they held in the company. The current price of the share is €2 or 200 cents. To work out the gross dividend yield, you need to calculate what percentage of 200 cents is 10 cents. To do so, multiply the dividend by 100 and divide by the share price. In this example 10 x 100 divided by 200 = 5, so the gross dividend yield on shares in company A is 5 per cent.

Having got this far, there are a couple of things to note. The first is that gross yield figures take no account of tax. While they can be used, imperfectly as we shall see for the purposes of comparison, they are not relevant to what a shareholder will receive, because tax will be deducted at source on the dividend by the company at the basic rate and the shareholder must declare the income and face tax at the full marginal rate.

Turning to comparisons, the gross yield is subject to frequent change for two obvious reasons. The first is that the gross dividend itself may alter - albeit only on those two occasions a year when companies announce dividend decisions with interim and full-year results. The other is more frequent. The gross yield will be adjusted, possibly significantly by any change in the price of the share. If you get the sort of run on the share that some technology issues recently experienced, this can have a fairly substantial effect on the yield.

Using the yield as a sole point of comparison between one share and another is not valid for a number of reasons.

In the first place, there is a question of what the shareholder wants from the investment. Gross dividend yield is simply a fluctuating indicator of the income one may expect from the investment. However, a large number of investors rely as much or more on the capital gain from their shares - the difference in the share price between the time they buy the stock and sell it - for their profit on the investment.

For instance, it is quite possible that a shareholder would receive a gross yield of 5 per cent on company A above, while receiving a yield of 12 per cent on company B. For example: if the shareholder buys €100 worth of both stocks and sells them at the end of a year; in that time, he will have earned €5 in income on company A and €12 gross income on company B, however, upon selling he nets a capital gain of €15 on the shares in company A as the share price has risen 15 per cent over the year and just €2 in company B because its price has remained fairly static.

In total, the investor has made €17 on his €100 investment in company A and only €14 on company B despite the higher yield.

So it is not as cut and dried as it might seem. As a rule, companies with lower yields tend to be younger companies or more expansionary ones. Shareholders invest in these hoping for income at a later stage due to higher dividends on the back of bigger profits and capital gains on rising share values.

Companies on a higher gross yield are often more mature groups with profits which are likely to grow more slowly, or those where the risk to the investor is higher, such as exploration stocks.

As always with rules on stock picking, such presumptions are made to be disappointed, but it is reasonable that people will expect a higher yield now if there is less potential ahead and vice versa.

It's always worth remembering that companies are loath to cut dividends because of the negative impression it gives the markets and potential investors. As a result, companies will sometimes dip into their reserves to preserve a dividend even when the financial performance of the year in question does not warrant it. This will generally skew the yield, as the price of such companies is generally lower compared to the yield, than that of companies with healthy figures and/or prospects in which the market has more confidence.

As you can see, there are a lot of issues to consider apart simply from the bald gross-yield figure. After all, the yield of a company which has preserved its dividend artificially and whose share price is falling sharply will look good; that doesn't mean it would make a good investment.