All about annualized yield

I got a few questions from readers yesterday about how I calculated the annualized yield of the OceanaGold PH [OGP 13.58, up 0.7%; 309% avgVol] Q2 dividend [link] so I thought that I would walk everyone through how I calculate annualized yield, why I do it, and the benefits and limitations of using annualized yield generally.

> First, the background:  OGP declared a $0.0066/share Q2 dividend out of its free cash flow for the period. Since OGP listed on May 13 and Q2 ends on June 30, the dividend was only sourced out of the free cash flow from this period. Inclusive of May 13th and June 30th, the period is 49 days in length. This was OGP’s first dividend as a public company, and its first as part of its plan to declare quarterly dividends of at least 90% of its free cash flow.

> What is annualization?  Annualization is a way for us to compare investment options that might have different dividend timelines by converting a single dividend (like a quarterly dividend, in this case) into an annual figure. We always talk about the dividend yields of fixed-income and dividend stocks using full-year figures. It’s important to remember, however, that when we annualize we also make certain assumptions and that any changes to those assumptions might result in a dramatic change to the company’s actual future dividends. Annualization is just a tool for comparison and estimation. Put bluntly, annualization says: “What would the full-year dividend look like if every dividend this year looked just like this last one?”

> Let’s annualize it!  Ok, with that out of the way, the first thing we will do to annualize OGP's div is convert the USD dividend to PHP. While this conversion will happen automatically on the payment day at whatever the exchange rate will be on that date, I just converted it at the current exchange rate to come up with a Q2 dividend amount of P0.39/share. If this were a regular quarterly dividend, annualization would be easy because we’d just multiply this dividend by four (there are four quarters in a full year) and divide by the current stock price, but this one is slightly more complicated because the dividend represents only a portion of the full quarter. My method of solving this was to calculate how much dividend was generated per day of the period, then multiply this by the number of days in a full year, and then divide that by the current stock price. To do that, we take the P0.39 dividend, divide that by the number of days in the period (49) to get P0.00795918367/day, and then multiply that by 365 to get a full-year dividend total of P2.91/share. Divide that by the current market price (which at the time was P13.48/share, and you get an annualized yield of 21.55%.

> Annualization benefits:  Without annualizing, we’d have no frame of reference to compare what OGP declared against the declarations of other dividend-generating stocks, like AREIT [AREIT 38.00, up 2.7%; 340% avgVol]. AREIT’s Q2 dividend was P0.56/share. Is that better than OGP’s Q2 dividend of P0.39/share? We need to know more. How much are the stocks? AREIT last traded for P38.00/share and OGP for P13.58/share. Using the per-day annualization method, we can then compare the annualized yields of each company’s Q2 dividends. AREIT’s annualized yield is 5.89%, and OGP’s annualized yield is 21.40%. 

> Annualization limits:  As I hinted at before, annualization is just one tool of many that we can use to compare income streams, and there are some important limitations that we need to be aware of. The first is that when we annualize, we assume a great deal about the company’s operations. Due to the nature of AREIT’s leasing business, its short-term income stream comes from rents that are paid under the force of contract. It’s pretty safe for us to assume that what happened last month with AREIT is pretty representative of what will happen this month since a lot of AREIT’s lease contracts are long-term in nature and not subject to short-term price fluctuations. The same is not necessarily true of OGP. As a mining firm, its production can be higher or lower (significantly or otherwise) for a variety of reasons that are both within the company’s realm of influence (production accidents, improved machinery, etc) and without (storms that delay operations). There’s also the added factor of price. OGP’s selling price each quarter is influenced by the spot price of gold as a commodity, and while OGP has the ability to manage its inventory, it has no control over the spot price of gold. Our annualization of OGP’s Q2 dividend assumes that it will produce and sell the same amount of gold per day for a whole year as it did during that 49-day span, that the average price it gets for all that gold will be the same, and that all of the other incomes and expenses will be the same. 

> So which one is better?  That depends on you. Both are long-term, dividend-generating stocks. AREIT has a long track record of delivering dividend growth, a trusted management team, and the “Ayala” name. OGP is new to the PSE, new to declaring dividends under its current dividend policy, and involved in a business that is subject to a considerable amount of risk. Great rewards can come to those who are willing to accept a higher degree of risk, but investors are not entitled to rewards, and we each have a different set of circumstances and preferences guiding our decisions. 

MB bottom-line: Annualized yields are just one weapon at your disposal. I think of it like a layup in basketball. While I’m too old (and short) to dunk, and my long-distance accuracy leaves a lot to be desired, I wouldn’t play a game with the idea that I’d ONLY take layups and never shoot from mid- or long-distance. The goal is to score points, and sometimes you get those points with a layup, and sometimes you get them with a clumsy off-balance floater from an awkward distance because you got too tired to lower your shoulder and it’s really hot outside. This is actually a terrible analogy, but the point here is to underline that it’s not the only tool that we can use to compare income streams, but I feel that it’s an important tool to understand as it will help us make those comparisons, and that can be especially useful when (as here) the companies are in vastly different industries and (as here) the dividends cover periods of differing duration. You may be a “TTM-4-lyfe” type of investor, and that’s fine. What works for you works for you. Annualization works for me, and while I’m probably more willing to use it than some of my conservative friends, it’s not the only thing I consider when I’m making my investment decisions.

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