# Money Math for Teens. Dividend-Paying Stocks

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1 Money Math for Teens Dividend-Paying Stocks

2 This Money Math for Teens lesson is part of a series created by Generation Money, a multimedia financial literacy initiative of the FINRA Investor Education Foundation, Channel One News and America Saves. Special thanks to Rudy Gawron for preparing the lesson and to Jill Sulam of Transformations Editing LLC for editorial guidance. Money Math for Teens. Copyright 2014 by the FINRA Investor Education Foundation or FINRA Foundation. Reproduction for nonprofit, educational purposes is permitted and encouraged. All rights reserved.

3 Lesson Plan OBJECTIVE Introduce students to fundamental concepts of investing in dividendpaying stocks as an alternative to low-yield savings accounts and money market accounts. Students will: Understand the vocabulary associated with dividend-paying stocks Calculate yield on a stock purchase at any particular value Analyze different options for building a portfolio of dividend-paying stocks Calculate return on investment, taking into account price swings and dividend payouts. TEACHING MATERIALS Lesson plan Dividend-Paying Stocks student handout Student assessment worksheet with solutions LESSON ACTIVITY 1. Determine students prior knowledge of fundamental vocabulary and concepts. Suggested questions: How many of you have a savings account? Do you know the interest rate on the account? How have interest rates changed in the last 10 years? How do rates change, who changes them and why do they change? What economic environments cause rates to rise and fall? Have you heard of a dividend? If so, what is it? 2. Introduce the student handout. Ask students to read pages 5 and 6, up to the Stocks section. Ask the class to answer the questions on page 6: What do you do with your extra money? If you spend it, what do you buy? If you save it, how do you do it? Would you still put it in a bank savings account? Why or why not? Would you be open to a different savings method? Are there alternatives available that would bring you a 4% to 6% return? 1 Introduction

4 3. Stocks and dividends (page 7 of handout): A share of stock is ownership in a corporation. Stocks trade on stock markets. Stock prices fluctuate, meaning they go up and down. Dividends are sums of money paid by a corporation to shareholders. Yield: dividend earnings expressed as a percentage of an investment. Introduce the formula for calculating yield: Dividend 1.60 Yield = = = = 6.4% Current Stock Price 25 Solutions to yield problems (page 10 of handout): Stock Price Dividend Yield Ask students: \$20. \$ = 4% \$40. \$ = 3% \$58.50 \$ = 3.6% \$82. \$ = 1.9% What effect on a stock s price would you expect after a company announces it is raising its dividend? It would make the stock more attractive and therefore tend to give the stock price a boost. Do you think a company raising its dividend is always a signal of the company s strength? Could a struggling company raise its dividend to get its stock price to rise? What is stock price appreciation? 4. Comprehension check (page 9 of student handout): You invested \$1,0 in a dividend-paying stock that cost \$20 per share and paid \$0.80 per year in a dividend. Exactly one year later you sold that same stock at \$23 per share. What would be your return on investment? How many shares of stock did you purchase? 10/20 = 50 shares What was the dividend yield expected at the time of purchase? 0.80/20 = 0.04 = 4% How much money did you collect in dividends? 0.80 x 50 = \$40 2 Introduction

6 7. Strategy for earning a desired 10% return on investment (pages of handout): Let s say you ve invested in a \$50 stock paying a \$2 dividend, and you want an overall 10% return. This investment has a 4% annual yield, or 1% per quarter. Holding the investment for 10 quarters (2.5 years) will result in a 10% return from dividends. A rise in stock price to \$55 per share is a 10% return on price appreciation, assuming the investment was held for a short term and no dividends had yet been received. After one year of receiving dividends, a 4% return has been realized. It would take a \$3 rise in stock price to \$53 to achieve a 6% increase and complete the 10% desired return. 8. Sample stock quote from IBM (via Yahoo Finance): Illustrates pertinent information about currently trading shares of stock. In particular, the 52-week stock price range, dividend and yield information are highlighted for students. 9. Evaluate students comprehension (see assessment worksheet). 4 Introduction

8 Here is a chart showing the average interest rate on certificates of deposit dating back almost 30 years. You ll notice that rates haven t been this bad for savers in all that time. CD rates history By Denise Mazzucco Bankrate.com This chart shows trends of the national average CD rates on 6-month CD yields, 1-year CD yields and 5-year CD yields since 1984, according to Bankrate s weekly survey on interest rates. So: What do you do with your extra money? Would you still put it in a bank savings account? Why or why not? Are there alternatives available that would bring you a 4% to 6% return? 6

9 Stocks You ve heard of the stock market, but what exactly are stocks? A share of stock in a corporation is a share of ownership. When you buy a share of stock, you are buying an ownership position in that company. If the company does well, the stock price rises. If you then sell that share at a higher price, you make money. If the stock price falls and you sell it at a lower price than what you paid, you lose money. Investing money in stocks brings with it an element of risk. If the stock price falls, you can lose money that s a risk. Stock prices fluctuate every second of every minute of every day that the stock market is open. But you don t need to concern yourself with these constant fluctuations. The current price of a stock doesn t affect your investment until you are ready to sell it. You purchased the stock at a certain price, and your investment is fixed at that price. If the stock has risen in price since you bought it, then selling it will bring you a profit. If you buy shares, hold onto them and aren t selling the stock today, then the current price doesn t really matter. A good reason to purchase shares of stock and hold them for long periods of time is known as dividends. What Are Dividends? Some corporations pay dividends to their shareholders. A dividend is a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits (or reserves). Companies sometimes reward their shareholders by paying them a portion of their profits. If you purchase shares of a company that pays dividends and you hold on to those shares for a prolonged period of time, you will get paid. Typically every quarter, a company will pay ¼ of its annual dividend amount. For example, if a company pays a \$2 annual dividend per share of stock, then you will receive \$0.50 per share you own each quarter. Regardless of the daily stock price, you will continue to receive dividends each quarter, as long as you own the stock and as long as the company continues to pay that dividend. Yield Yield is the ratio of the dividend amount to the current stock price. You can calculate the yield you will receive from holding a stock and accumulating the dividends before you buy it. Just divide the annual dividend amount by the current stock price: Yield = Dividend Current Stock Price 7

10 Example >>> Metro Corporation is currently selling stock at \$25 per share. The company pays a \$1.60 dividend per year Yield = = = 6.4% 25 That s right you ll earn a 6.4% yield on your \$25 investment! Calculate the yield you would get if you purchased these shares of dividendpaying stock at these prices: Stock Price Dividend Yield \$20. \$0.80 \$40. \$1.20 \$58.50 \$2.10 \$82. \$1.55 Benefits of Dividend-Paying Stocks In recent years, dividend-paying stocks have become a popular investment for investors focused on income-producing investments. This is because traditional fixed-income investments like bank accounts and certificates of deposit are yielding next to nothing. Over time, stocks that pay a high dividend tend to outperform stocks that do not. From 1972 through September 2010, US-based dividend-paying stocks returned an average of 7.1% increase in price annually. Compared to the 1.5% average annual increase of non-dividend paying stocks, dividends are clearly an attractive choice. Dividend-paying stocks have historically outperformed the overall stock market during periods when stock prices are weak. Investors gravitate toward dividend-paying companies during times of economic trouble. Companies that pay dividends are generally more conservative and have stronger cash flows, which allow them to pay their investors dividends in the first place. By paying dividends, companies indicate the strength of their business by showing that they are comfortable paying shareholders instead of saving their earnings for tough times. Investing in dividend-paying stocks offers two possible ways to earn money: price appreciation of the stock itself and the dividends received by holding the stock long term. 8

12 Risk vs. Reward Before you run out and research companies with the highest-yield dividends, let s talk a bit more about risk. In some cases, a high-yield dividend can be a warning sign. Not every company with a high dividend has strong fundamentals supporting that dividend, such as good earnings. A high dividend can be an attempt to lure investors into buying the stock of a company in trouble, one that cannot continue to pay that dividend in the future. It also can be an attempt to attract attention to a stock and raise its price, but the price of the stock may be depressed for some fundamental reason. Research is important in determining if a company offering a nice dividend is actually risky. Here are tips to keep in mind. Solid, mature, well-established companies raise dividends consistently. Good companies that reward their shareholders have reputations to protect. Paying consistent dividends to shareholders builds investors trust, and that s a reputation most good companies would not risk. Consistent dividends will compound over time. If you reinvest the dividends you earn into buying more shares, you will consistently earn still more dividends. Some companies have been paying dividends and raising them every year for decades. This is a streak many companies wouldn t want to break. A dividend aristocrat is a Standard & Poor s 5 Index (S&P 5) company that has raised its dividend every year for the past 25 years. A dividend achiever has raised its dividend every year for the past 10 years. The S&P 5 is an index of 5 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 5 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe (companies with a market value of \$5 billion or more). Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor s. The S&P 5 is a market value weighted index each stock s weight is proportionate to its market value. Source of this definition: sp5.asp 10

15 Then there s the blended approach. You can achieve a 10% return in less than 30 months if you are lucky enough to get some price appreciation along with dividends. If you held your stock for exactly one year, what would the stock price have to be on that day in order for you to sell the stock and achieve your 10% return? Since you held the stock for one year, you have received 4% already by collecting the dividends. To achieve the desired 10% return, you d need a 6% increase in the stock price. 1% of 50 = % of 50 = 6 x 0.50 = = 53 The stock price would have to be \$53 for you to make the 6% return you want. Using a blended approach, you collected 4% in dividends and made another 6% on stock price appreciation and thus achieved your desired 10% return in one year or four quarters. Each of these three methods will work, and no method is better than the others. It all comes down to your patience and tolerance of risk. Getting Started You can start learning about stocks and dividends by getting a current stock quote. This stock quote for IBM (below) was taken from Yahoo.com s Financial tab. To find quotes for stocks you re interested in, go to finance.yahoo.com, type the symbol for a particular stock in the box at the top left, and click Look Up. If you don t know the company s stock symbol, type the company s name in the quote look-up box and a list of companies, with their symbols, appears. 13

16 Stock quotes provide a lot of information. We ve circled two important pieces in the quote below: B A Point A: Shows the current annual dividend the stock is paying, as well as the yield at this stock price. Point B: Shows the 52-week range of the stock s price. When trying to determine if the current price of a stock is too high, too low or in the middle, it can be useful to know its price range. IBM is trading at about \$193 per share, about 21 points above its low point for the year and 19 points below its high point. If investing in dividend-paying stocks seems like a reasonable alternative to a bank savings account and you accept the risk involved with investing in stocks, then it is possible for you to achieve nice growth. Keeping an eye on your investments will help you enjoy long-term success. 14

17 Name Date Assessment: Dividend-Paying Stocks 1. Metro Corp. is currently selling stock at \$32.50 per share with a \$0.90 dividend. If you purchase 1 shares at the current price, what yield will you expect as a return on your investment? 2. Metro Corp. is currently selling stock at \$32.50 per share with a \$0.90 dividend. You invest \$1,625 with no brokerage commissions and hold the stock for one year. How much income will you earn? 3. After the year is up, Metro Corp. is selling stock at \$28 per share. You purchase the same number of shares again at the new price. What is the blended (average) yield you are now earning? 4. Metro Corp. is doing well and announces an increase in its dividend to \$1.02 per share. The stock price shoots up to \$ What is your new annual yield? 5. How long would you need to hold a \$14 stock paying a \$0.56 annual dividend to achieve a 10% return? 15 Assessment: Dividend-Paying Stocks

18 Name Date The following table shows the life cycle of a single stock investment. Use this data to answer questions Date of Transaction Transaction Executed Dividend on This Date 01/01/2011 Purchase 50 shares at \$17.50/share \$ /08/2011 Purchase 75 shares at \$15./share \$ /01/2012 Purchase 75 shares at \$22.50/share \$ /29/2012 Sell entire holding at \$24.10/share 6. What dividend dollar amount was earned in 2011? 7. What dividend yield was earned in 2011? 8. What dividend dollar amount was earned over the life of the investment? 9. What was the dividend yield of this stock on April 1, 2012? 10. What was this investment s total return? 16 Assessment: Dividend-Paying Stocks

19 Assessment Solutions: Dividend-Paying Stocks 1. Metro Corp. is currently selling stock at \$32.50 per share with a \$0.90 dividend. If you purchase 1 shares at the current price, what yield will you expect as a return on your investment? 0.90/32.50 = = 2.8% 2. Metro Corp. is currently selling stock at \$32.50 per share with a \$0.90 dividend. You invest \$1,625 with no brokerage commissions and hold the stock for one year. How much income will you earn? 1625/32.50 = 50 shares 50 x 0.90 = \$45 3. After the year is up, Metro Corp. is selling stock at \$28 per share. You purchase the same number of shares again at the new price. What is the blended (average) yield you are now earning? 50 shares x 28 = \$ = \$ x 1 = \$90 90/3025 = = 3% 4. Metro Corp. is doing well and announces an increase in its dividend to \$1.02 per share. The stock price shoots up to \$ What is your new annual yield? 1.02 x 1 shares = \$ /3025 = = 3.4% 5. How long would you need to hold a \$14 stock paying a \$0.56 annual dividend to achieve a 10% return? 0.56/14 = 0.04 = 4% annual return, so 2 years = 8% and 2.5 years = 10% or 0.1 x 14 = \$ /0.56 = 2.5 years = 10 quarters 17 Assessment Solutions: Dividend-Paying Stocks

20 The following table shows the life cycle of a single stock investment. Use this data to answer questions Date of Transaction Transaction Executed Dividend on This Date 01/01/2011 Purchase 50 shares at \$17.50/share \$ /08/2011 Purchase 75 shares at \$15./share \$ /01/2012 Purchase 75 shares at \$22.50/share \$ /29/2012 Sell entire holding at \$24.10/share 6. What dividend dollar amount was earned in 2011? 0.30 x 50 = \$15 (0.30 x 75)/2 = 22.50/2 = \$11.25 (July purchase received half-year dividend [2 quarters]) = \$ What dividend yield was earned in 2011? Investment: 50 x = \$ x 15 = \$1,125 Dividends: 0.30 x 50 = \$15 (0.30 x 75)/2 = 22.50/2 = \$11.25 (July purchase received half-year dividend [2 quarters]) Yield: Yield = ( ) = ( ) 20 = = 1.3% 8. What dividend dollar amount was earned over the life of the investment? 2011: \$ : 1 quarter earned on 125 \$0.30: (0.30 x 125)/4 = 37.50/4 = \$ quarter earned on 2 \$0.35: (0.35 x 2)/4 = 70/4 = \$ total: = \$26.88 Life of the investment: = \$ Assessment Solutions: Dividend-Paying Stocks

21 9. What was the dividend yield of this stock on April 1, 2012? 0.35 Yield = = = 1.6% What was this investment s total return? Investment: 50 x = \$ x 15 = \$1, x = \$1, = \$3, invested Sale: 2 x = \$4,820 Earnings: = \$1, price appreciation = \$1, price appreciation + dividends collected / = = 32.2% total return 19 Assessment Solutions: Dividend-Paying Stocks

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