With interest rates going lower, investors are seeking income elsewhere and turning to higher yields. A popular thought in response is to seek out the best dividend paying trusts or companies based on yield. This Yield is calculated as the annual income (distribution) divided by share price with the thought a higher % is best (ie more income). BUT…do we spend %’s to live or do we spend $’s to live? Here in lies what is called the “Yield Trap”.
To illustrate the trap and why yield is not the most important factor, the graph shows the growth in share value and dividends for CSL Ltd from May 1994 to August 2019. We have picked this company as the % YIELD is LOW.
With CSL’s current yield of 0.99%, an investor focusing solely on % yield may disregard investing in CSL. However, the blind spot with using yield is as company profits grow, $ dividends also grow, and the share price increases which means the yield remains the same (LOW) over time. YET as per the chart above, CSL’s share price and annual $ dividends have grown significantly over time, but the yield has remained static. The investor focusing on dividend yield would miss great companies like CSL which actually provide the growing $ income stream and capital growth the very same investor is seeking. The moral of the story is to invest in companies which provide growing profits -> growing dividends -> capital growth over time.