If You're a Dividend Investor, You Need to Know About This Powerful Strategy

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Dividend investing is one of the most popular and time-proven investing strategies around. Shareholder yield is a similar concept, and it could even provide superior returns for investors. What is shareholder yield, and how can you profit from it?

Understanding shareholder yield
A company has basically five possible choices when it comes to allocating capital: reinvesting in the business, making acquisitions, paying dividends, repurchasing shares, or paying down debt. The last three alternatives -- dividends, buybacks, and debt paydowns -- are capital distributions.

Shareholder yield measures how much money the company is distributing in comparison with its market capitalization, and it's calculated as the sum of three components: dividend yield, buyback yield, and debt paydown yield.

Dividend yield is the most popular and well-known yield measure. It's calculated as total dividend payments over company's market capitalization, or dividends per share over the stock price. Buyback yield measures net share buybacks over market capitalization, and debt paydown yield is calculated as net debt reductions over market capitalization.

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There are important differences between buybacks and dividends as a method to distribute cash to shareholders. Depending on the particular case and specific circumstances, buybacks can be better than dividends, or vice versa. However, the fact remains that many companies are increasingly choosing buybacks over dividends as way to reward investors, so incorporating buybacks into the mix sounds like a smart idea.

Sometimes it makes sense to issue debt to pay dividends or repurchase stock. However, by including net debt reductions, shareholder yield avoids those situations in which most of the cash distributed to shareholders comes from debt as opposed to internally generated funds. Money coming from operating the business is a more sustainable source of capital distribution over the long term.

Why you should invest in companies with high shareholder yield
In a nutshell, by also including share buybacks and debt paydowns, shareholder yield provides a more holistic and complete approach to capital distributions than dividend yield alone. Importantly, some statistical studies have found that focusing on shareholder yield can produce superior returns for investors over the years.

In the excellent book Shareholder Yield: A Better Approach to Dividend Investing, author Mebane Faber compares the returns obtained by investing in a basket of stocks selected by dividend yield alone or by shareholder yield, and the results are quite interesting.

From 1982 to 2011, a basket of high-dividend-yield stocks produced an average return of 13.4% per year, comfortably beating the S&P 500 Index and its annual return of 10.96% over that period. However, companies with high shareholder yield did even better, delivering a 5.04% gain per year through that period.

The difference in returns can have a big impact on your capital over the years. Based on these returns, a $10,000 investment in the S&P 500 would turn into $28,292 after 10 years, the same amount of money invested in high-dividend-yield stocks would become $35,166, and that money invested in high-shareholder-yield companies would turn into $40,196 after a decade.

Capitalizing on the power of shareholder yield
When it comes to investing in solid companies with big shareholder yields, Apple looks like a particularly interesting name, as the tech powerhouse pays a shareholder yield of 7.96%, based on data from YCharts.

Over the past year, Apple has distributed over $57 billion in dividends and share buybacks. This is a massive amount of money, even for the biggest listed company on the planet. Apple is issuing debt, but that's only to avoid paying taxes on foreign cash repatriation, since the company is sitting on nearly $178 billion in cash and liquid investments on its balance sheet.

Procter & Gamble pays a shareholder yield of 5.4%, which sounds like quite a convenient yield coming from a global consumer leader with an extraordinary trajectory of dividend payments. Procter & Gamble has raised its dividends for the past 58 years in a row, and the company has paid uninterrupted dividends for 124 years.

Procter & Gamble is being hurt by the negative impact from currency fluctuations, but the company is still a cash flow-generating machine. In the last quarter Procter & Gamble produced $3.4 billion in operating cash flow and $3 billion in adjusted free cash flow. The company returned $3.7 billion in cash to shareholders, including $1.8 billion in dividends and $1.9 billion in share buybacks.

Philip Morris is another consumer company with a smoking-hot shareholder yield of 7.5%. The business is financially solid, as Philip Morris has been able to buffer the decline in cigarette sales volume with price increases and strict cost discipline over the past several years. However, investing in the tobacco business exposes investors to some considerable risks because of the negative health impact of the product and all the regulatory uncertainty that comes with it.

Since 2008, Philip Morris has increased dividends by more than 117%, to an annual dividend of $4 per share, representing a dividend yield of almost 5% at current prices. In addition, the company plans to distribute nearly $4 billion to shareholders through share buybacks in 2015.

Dividend investing has proved to be a smart and remarkably successful strategy over the long term. Shareholder yield builds on the same principles, and it provides a broader view of a company's overall capital distributions. With this in mind, dividend investors may want to add this weapon to their investing knowledge arsenal.

The article If You're a Dividend Investor, You Need to Know About This Powerful Strategy originally appeared on Fool.com.

Andrs Cardenal owns shares of Apple. The Motley Fool recommends Apple and Procter & Gamble. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.