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Tim Hortons is exactly the type of company we would expect to show steady dividend growth, but there are lesser known firms that deserve a look. (Chris Bolin For The Globe and Mail)
Tim Hortons is exactly the type of company we would expect to show steady dividend growth, but there are lesser known firms that deserve a look. (Chris Bolin For The Globe and Mail)

Investor Clinic

Clearing up confusion about yields and dividend growth Add to ...

Please help me understand something. In a recent article you said Tim Hortons’ dividend yield is 1.8 per cent and its five-year dividend growth is 24.6 per cent. Does this mean that five years ago its yield was 1.8 per cent less 24.6 per cent – in other words, approximately 1.4 per cent?

No. I think you may be confusing a few things.

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Let me break your question down into two parts, starting with the dividend yield.

Currently, Tim Hortons pays a dividend of 21 cents a quarter, or 84 cents annually.

On Thursday, the stock closed at $46.52.

The yield is therefore 84 cents divided by $46.52, or about 1.8 per cent. (You can look up the annual dividend and yield for any stock by entering the symbol in the search box at globeinvestor.com.)

The general formula for dividend yield is: annual dividend divided by share price, expressed as a percentage. Looking at the formula, you can see that the yield will change if a) the dividend changes, or b) the stock price changes.

For example, if the dividend goes up, so will the yield (assuming the stock price doesn’t change). If the stock price goes up, the yield will fall, and vice-versa (assuming the dividend doesn’t change).

For many readers, all of this will be second nature. But judging from the e-mails I get, some newbie investors have difficulty grasping these concepts.

Now, to your question about the five-year dividend growth. This has nothing to do with the price of the stock. It represents how much the actual dividend – not the yield – has grown over the past five years, expressed as an annualized percentage.

Let’s go back to Tim Hortons.

Five years ago, the coffee and doughnut chain was paying a quarterly dividend of 7 cents a share. Currently, it is paying 21 cents a share quarterly. So the dividend has tripled over that period. The question is: what annual compound growth rate would be required to make the dividend triple over those five years?

To figure out the answer, you can use a financial calculator or a free online compound interest calculator such as the one at 1728.org. You would enter 7 for the initial principal, 21 for the final value, 5 for the number of years, and then solve for the annual rate. The answer you’d get is 24.57 per cent (in my column the other day I rounded up to 24.6 per cent).

That’s how much Tim Hortons’ dividend grew on an annualized basis over the past five years. Keep in mind that in any given year the growth rate probably wasn’t exactly 24.57 per cent; it was lower in some years, and higher in others. (You can check to see whether the answer is correct by multiplying 7 by 1.2457 five consecutive times. You should end up with 21.)

Follow on Twitter: @johnheinzl

 

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