Both dividend yield and total return are terms used to describe the performance of a stock over a certain time period (usually one year), but they reflect different types of performance. Whether equity investors should focus on income generation, which includes dividend yield, or return is a contested topic in the financial world. In truth, the relative importance of each measurement likely depends on your individual circumstances and investment horizon. This does not mean you have to neglect one in favor of the other; it is wiser to consider both before selecting an investment.
The Importance of Dividend Yield
Dividends are the portion of a company's profits that are distributed to shareholders. It is considered a sign of clear financial health and confidence for a company to pay out dividends, which are usually independent of the share price. The dividend yield is a financial ratio that represents the dividend income per share, divided by the price per share. For example, a stock priced at $100 per share that receives a dividend payment of $8 is said to have a yield of 8%.
For long-term investors, dividends can be very powerful, because they can be reinvested and used to purchase more shares, meaning the investor does not have to commit more of his or her resources to increase his or her equity holdings. Other investors rely on yields to produce a stream of income from their investments. Though not quite as reliable as fixed-income investments such as bonds, dividend-producing stocks can be quite valuable in this way.
Yield, however, can be misleading. Some companies continue to pay yields even when they are operating at a short-term loss, while other companies pay out yields too aggressively and fail to reinvest enough profit to sustain operations down the road.
The Importance of Total Return
Total return, often referred to as "return," is a very straightforward representation of how much an investment has made for the shareholder. While the dividend yield only takes into account actual cash dividends, total return accounts for interest, dividends, and increases in share price among other capital gains. On the surface, this appears to provide a more encompassing, and therefore useful, performance metric than the dividend yield. However, a return is entirely retrospective, and share prices can increase for a huge number of reasons. It is typically more difficult to project future investment performance from the stock's return than from its dividend yield.
Which Is More Important?
The importance is relative and specific to each investor. If you only care about identifying which stocks have performed better over a period of time, the total return is more important than the dividend yield. If you are relying on your investments to provide consistent income, the dividend yield is more important. If you have a long-term investment horizon and plan on holding a portfolio for a long time, it makes more sense to focus on total return. However, the evaluation of a company for potential equity investment should never come down to just these two figures; rather, look at the company's balance sheet and income statement, and perform additional research as well.