Dividend Yield is a ratio of dividend paid last year to current market price. A further reading on Dividend Yields can be found here.
One of the two metrics used to evaluate over- or under-valuation of markets is Dividend Yield (Other is P/E Ratio). At present (Mid January 2012), Nifty has a dividend yield of 1.6(find latest data here).
So is this a right time to invest? We at Stable Investor decided to look into index’s history to answer this question.
Analysis of Nifty’s last 13 years data (from 1st Jan 1999 onwards) reveals a few interesting points –
Returns during last 13 years, when segregated on basis of Dividend Yields are –
This clearly indicates that at current Dividend Yield of 1.6, chances of earning around 20% per annum for next 3 years are quite high! (Caution – The statement is made on basis of historical data. Past performance is no guarantee of future performance.)
A graph between Dividend Yields and 3-Year-Returns (CAGR) also shows that there is a high (positive) correlation between the two. Higher the dividend yield, higher the returns over 3 year periods.
Dividend Yield & Return Since 1991 [Click to Enlarge]
But one must understand that market does not give enough chances at higher levels. Our analysis shows that out of 2500 trading sessions in last 13 years, markets spent less than 5% (127 days) at dividend yields of more than 2.5 (which offers maximum returns over 3 year periods).
Days Spent on various Dividend Yields
So after this analysis, Stable Investor understandsthat though history shows that investing in markets offering high dividend yields makes more sense, one should never rely on just one mathematical tool to arrive at any investment decision. Any number should be taken with a pinch of salt and should always be looked in conjunction with other ratios and numbers.
We did a similar analysis of PE Ratios and Returns over 3 and 5 year periods and arrived at some remarkably useful results which can be found in the post Relation between PE Ratios and Returns.
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