Do you ever wondered about this - Imagine you have a stock which you had bought at $1.20. The price now is $1.80. It gives out dividend (not guaranteed, of course) at a rate of 5 cents per annum last year (dividend yield of 4.2%), with possibility of increasing its yield every year. Will you sell the stock for capital gains of 60 cts (1.80 - 1.20 = 60 cts) but forsaking 5 cents or more dividends forever? Here's a few ways to valuate this: 1. Assuming that the dividend is fixed at 5 cts forever, it'll take 12 yrs (60/5 = 12) for the dividend (if you hold the stock) to cover the present capital gain (if you sell it now at $1.80). Which do you think is better - 60 cts gain now or 60 cts gain over 12 yrs. Of course, the complications come in when you talk about the possible capital gain (or loss) if you hold the stocks for 12 years. The company might be bankrupt, it might freeze or cut dividends, it might give more and so on. It's never easy to decide. 2. The first method does not take into account the time value of money. It's better to do a discounted dividend approach to account for the time/money relationship. Below shows my calculation, assuming there is no change in the dividend given per year. I assume a discount rate of 4% (why? that's the inflation rate I assumed) to account for the opportunity cost of holding cash. Read more...