Simply put, dividends are the primary method by which a publicly traded company distributes profits to shareholders.
Are you ready to understand “What is a good dividend yield?” in simple terms? You may also want to simplify your knowledge of what a dividend is and why you might want to buy one.
In this article, we’ll take a closer look at what constitutes a good dividend yield, how dividend yield is calculated, what a ‘high’ and ‘low’ dividend yield is, and what it means. Let’s dive in.
What is Dividend Yield?
Dividend yield refers to the amount of money a stock pays when you own it. Dividends are money a company pays to investors, usually from earnings (but not always). They are a fundamental reason to own stocks and one of the reasons the stock market exists. Investments pay you to own them, either through capital gains or profits. Dividends show how a company distributes profits to shareholders in today’s stock market.
What is a good dividend yield for a portfolio? Of course, it’s a harder question to answer.
What is a good dividend yield?
What is a good dividend yield? It’s a loaded question.
What’s good for one company may not be good for another, nor is it good for your portfolio. A good yield is one that a company can sustain if they pay for it. A regular dividend is the foundation of a buy-and-hold mentality and something most companies hope for and strive for.
For convenience, a good return should be high relative to the broad market S&P 500 and the company’s peers. Ironically, you don’t even have to own stock for more than a day to get the dividend. To find out how, you need to know something the ex date versus the day of registration.
How is dividend yield calculated?
The dividend yield is easy to calculate. You determine the return by dividing the amount of dividend paid by the share price. There are two ways to calculate the yield: you can use the dividend payments over the next 12-month period (TTM) and you can also use the expected dividend payments over the next 12-month period.
Why is dividend yield useful?
The dividend yield is useful because it is one of only two reasons to own stocks: growth and dividends:
- Grow: The company is growing and the share will become more valuable in the future.
- dividends: The company shares its profits in the form of dividends. Dividends are also useful as a means of generating income, leveraging your portfolio by reinvesting dividends, and can help to counter the fall in inflation.
What is a good annual dividend yield? One that makes you smile when you think about it. One way to find it is by using the best dividend stocks tool.
When is a dividend yield too low?
When is a dividend yield too low? You have to answer that question yourself.
Some of the reasons why it could be too low could be due to your portfolio strategy, returns relative to peers, returns relative to the S&P 500, and risk relative to holding bonds. If the goal of the portfolio is low risk and you want to earn income without needing capital gains, your threshold may be lower than if the portfolio was more risk tolerant and you were looking for growth.
In all cases, consider owning a number of dividend stocks for diversification and security.
When is a dividend yield too high?
At face value, no dividend yield is too high, because higher is better as long as it is sustainable. In reality, dividends must be sustainable to be attractive to investors. Unfortunately, high yields are not always sustainable.
A dividend is too high when the company cannot sustain the payment. If there is a risk of a dividend cut or suspension, it could weigh on the share price and, even worse, could lead to a loss of capital if the cut or suspension continues.
What is a good dividend yield? In this case, it’s a dividend you can rely on.
What causes a high dividend yield?
There are many reasons that can affect the yield dividend stocks, including the payout amount and prize action. Let’s take a closer look at a few reasons:
- A stock’s dividend yield is a function of its payment. Assuming the price of the stock remains static, the higher the payment, the higher the return. The problem (or opportunity) for investors and traders, depending on how you look at it, is that a stock’s price is rarely static.
- A stock’s dividend yield is also a function of price action. Assuming the amount of the dividend payment remains static, which is so often the case, an upward movement in the stock price will reduce returns. The reverse of this is true if the share price goes lower. In that case, the yield would move higher and open up a potentially high return for investors.
- A stock’s dividend yield is also a function of data. Sometimes the data used to determine the displayed yield is based on past performance and not relevant to the future. An example is an MLP, REIT, or shipping stock that pays its monthly payment based on income. In some cases, traditional companies are governed by managed distribution plans that determine how much, how often, and when a dividend payment can be made. For example the company Cal-Maine Foods (NASDAQ: CALM) cannot make a distribution for any quarter of negative earnings, and the company cannot make a distribution until that lost income is made up.
- News can have a major impact on revenue. For example, news displayed on websites and in stock searches can send a stock quote into the trash and cause a huge spike in returns. The problem with this kind of “high yield” is that the news may have already included a dividend cut or suspension or could lead to a dividend cut in the future.
Evaluating high dividends for risk
High dividends are attractive to investors, because more is better, right? In the case of dividends, high payouts can be a red flag or, in some cases, an indication of problems that have already occurred. Check out a list of things to look at to know if a stock’s high returns are worth buying or not.
Compare the yield with peers
Dividend-paying stocks in the same industry tend to pay similar returns relative to their value. The first thing to check when evaluating a high return is to see if it is abnormally high for the group. A higher than average yield is one thing – it can be an opportunity. However, a significantly higher yield is reason enough to dive deeper into the details.
You get what you pay for. What you don’t want to pay for is a distribution discount or suspension that leaves stock prices in the dust.
View the dividend statistics
Most stock websites publish a list of common dividend metrics that you can use to weed out risky high-yield stocks. One of these metrics is the payout ratio, the compound annual growth rate (CAGR), and the years of consecutive increase.
The payout ratio indicates how much of a company’s earnings are paid out in dividends. In this case, lower is better and higher is worse. The higher the payout ratio, the less room in the cash flow for increasing dividends or paying for other things like growth.
The next metric is the CAGR, which tells you the rate of distribution increase, which can be more important than revenue. The higher the CAGR, the better, as it means return on investment continues to grow and should grow at a similar rate in the future.
The last statistic is the number of years of increases. This number can tell you a lot because a history of sustained dividend increases can be a powerful reason to buy and hold stocks. The top dividend stocks have a decades-long track record of raising dividends.
Check the balance
It doesn’t take an accountant to see red flags on a balance sheet. The easy-to-find numbers include cash and equivalents (known as liquidity) and the company’s debt, both short and long term. If the company has a healthy cash balance and little to no debt, the cash flow will be unimpeded by debt payments and free for use.
If not, the company could struggle to pay dividends or maintain its record of consecutive annual increases. You can check the leverage ratio, a measure of how much debt the company has to its assets. In this case, low is good. A leverage ratio below three is very good; under 10 is okay, depending on why the debt exists.
Find out what others are saying about the stock
Finally, what are others saying about the stock? Check the analyst ratings and the trend in analyst sentiment. If analysts warm up and this aligns with the fundamental outlook, the high yield dividend stock is likely a good buy. If analyst sentiment cools, you may want to avoid it. After that, check out the headlines and find out if the company is struggling or encountering hurdles in any way that could affect results.
Good dividend yield is where you’ll find it
So, what is a good dividend yield? Simply put, it’s one that the company can sustain and that fits the portfolio’s needs.
You will cherish a good dividend yield, but good is relative. A good return for a technology stock can be a terrible return for a consumer staples stock – not all types of companies can maintain a “high return.” To find a good rate of return, make sure the company can afford it and compare it to others in the industry. If it looks attractive compared to its peers, then it is a good yielder.
Frequently Asked Questions
Do you have any questions about what constitutes a good dividend yield? There is no single answer to rule them all. However, we’ll dive into some common questions to help you understand which dividend yields are good and which ones you should avoid.
Is a 6% dividend yield good?
A dividend yield of 6% is good. That’s more than three times what the average S&P 500 company pays and well above the threshold for being considered high yield.
What is a too high dividend yield?
Excessive dividend yield refers to a dividend that is not sustainable. A 10% return from a highly leveraged growth stock is not the same as if it were paid by a REIT. To understand dividend yields that are too high, compare returns within industries and look at earnings, free cash flow, and balance sheet to see if the company has the money.
What is a good average dividend yield?
A good average dividend yield depends on the sector and the stock. Each sector tends to trade at a different valuation and they vary over time. To find “average” dividend yields, compare returns within an industry and against the broad market S&P 500.
- 1 What is Dividend Yield?
- 2 What is a good dividend yield?
- 3 How is dividend yield calculated?
- 4 Why is dividend yield useful?
- 5 When is a dividend yield too low?
- 6 When is a dividend yield too high?
- 7 Evaluating high dividends for risk
- 8 Good dividend yield is where you’ll find it
- 9 Frequently Asked Questions