Put simply, dividends are the primary method by which a publicly traded company returns profits to shareholders.
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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 go into deep detail on what makes a good dividend yield, how to calculate dividend yield, what “high” and “low” dividend yield is and what it means. Let’s dive in.
What is Dividend Yield?
The 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 foundational reason to own stocks and one of the reasons why the stock market exists. Investments pay you to own them, either through capital gains or profits. Dividends show how a company in today’s stock market pays profits to shareholders.
What is a good dividend yield for a portfolio? Naturally, it’s a tougher question to answer.
What is a Good Dividend Yield?
What is a good dividend yield? It’s a loaded question.
What is good for one company may not be good for another and neither may be good for your portfolio. A good yield is one that a company can sustain as they pay it. A regularly paid dividend is the foundation of a buy-and-hold mentality and something most companies hope for and strive to achieve.
For easy reference, a good yield 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 about the ex-date versus the day of record.
How is Dividend Yield Calculated?
The dividend yield is an easy calculation. You determine yield by dividing the dividend payout amount by the stock price. There are two ways to calculate yield: You can use the dividend payments over the trailing twelve-month (TTM) period and you can also use the expected dividend payments over the coming twelve-month period.
Why is Dividend Yield Useful?
The dividend yield is useful because it is one of only two reasons to own a stock — growth and dividends:
- Growth: The company is growing and the stock will be worth more 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 dividend reinvestment and they can help offset inflation decay.
What is a good annual dividend yield? One that makes you smile when you think about it. One way to find those is to use 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 for yourself.
Some of the reasons why it might be too low may be due to your portfolio strategy, the yield relative to peers, the yield relative to the S&P 500 and the risk relative to owning bonds. If the goal of the portfolio is low risk and you want to achieve income with no need for capital gains, your threshold may be lower than if the portfolio was more risk tolerant and if you were looking for growth.
In all cases, consider owning a number of dividend stocks for diversification and safety.
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 have to be sustainable in order 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 risk of a dividend cut or suspension, that could weigh on the share price and worse, it could cause the loss of capital if the cut or suspension comes to pass.
What is 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 could affect the yield dividend stocks, including the payout amount and the price action. Let’s take a look at a few reasons more in depth:
- A stock’s dividend yield is a function of its payment. Assuming the stock’s price remains static, the higher the payment, the higher the yield. 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 its price action. Assuming the dividend distribution amount remains static, which so often is the case, an upward movement in the stock price will reduce yield. The inverse of this is true if the stock’s price moves lower. In that case, the yield would move higher and open up a potentially high-yield opportunity for investors.
- A stock’s dividend yield is also a function of data. Sometimes the data used to determine the yield that is displayed is based on past results and not relevant to the future. One example is an MLP, REIT or shipping stock that pays its monthly payment based on income. In some cases, traditional corporations are governed by managed distribution plans that dictate how much, how often and when a dividend payment can get paid out. For example, the company Cal-Maine Foods (NASDAQ: CALM) cannot make a distribution for any quarter with negative earnings and the company cannot make a distribution until those lost earnings are made up.
- News can have a big impact on the yield. For example, news displayed on websites and in stock searches may send a stock price into the trash bin and spark a massive spike in yield. The trouble with this type of “high yield” is that the news may have already included a dividend cut or suspension or may lead to one 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 trouble that has already happened. Check out a list of things to review to know whether a stock’s high yield is worth buying or not.
Compare the Yield with Peers
Dividend-paying stocks in the same sector tend to pay out similar yields relative to their values. The first thing to check when evaluating a high yield is to see if it is abnormally high for the group. A higher-than-average yield is one thing — it could signal an opportunity. However, a significantly higher yield is reason enough to dig deeper into the details.
You get what you pay for. What you don’t want to pay for is a distribution cut or suspension that will leave share prices in the dust.
Check Out Dividend Statistics
Most stock websites will publish a list of commonly followed dividend statistics that you can use to weed out risky high-yield stocks. Among these metrics is the payout ratio, the compound annual growth rate (CAGR) and the years of consecutive increase.
The payout ratio tells you 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 dividend increases or paying for other things like growth.
The next statistic is the CAGR, which tells you the pace of distribution increase which can be more important than yield. The higher the CAGR, the better, because it means the yield on investment continues to grow and should grow at a similar pace in the future.
The final statistic is the number of years of increases. This figure can tell you a lot because a history of sustained dividend increases can be a powerful reason to buy and hold a stock. The top dividend stocks have a decades-long track record of dividend increases.
Check the Balance Sheet
It doesn’t take an accountant to see red flags on a balance sheet. The easy numbers to look for include cash and equivalents (known as liquidity) and the company’s debts, both short and long term. If the company has a healthy cash balance and little to no debt, the cash flow is unimpeded by debt payments and free for use.
If not, the company may have a hard time paying out dividends or sustaining its record of consecutive annual increases. You can check the leverage ratio, a measure of how much debt the company carries relative to its assets. In this case, low is good. A leverage ratio under three is very good; under 10 is okay depending on the reason why the debt exists.
Learn What Others Say About the Stock
Finally, what do others say about the stock? Check the analyst’s ratings and the trend in analyst sentiment. If the analysts are getting warmer and this matches the fundamental outlook, the high yield dividend stock is likely a good buy. If the analyst’s sentiment cools, you may want to avoid it. After that, check the headlines and find out whether the company struggles in any way or faces hurdles that may impact its results.
A Good Dividend Yield is Where You Find it
So, what’s a good dividend yield? Put simply, it’s one the company can sustain and which fits the needs of the portfolio.
You’ll treasure a good dividend yield, but good is relative. A good yield for a tech stock may be a horrible yield for a consumer staple stock — not all types of companies can sustain a “high yield.” To find a good yield, make sure the company can pay it and compare it to others in the sector. If it looks attractive relative to its peers, then it is a good yield.
FAQs
Still have some questions about what makes a good dividend yield? There’s no one single answer to rule them all. However, we’ll dive into some frequently asked questions to help you understand which dividend yields are good and which ones to avoid.
Is a 6% dividend yield good?
A 6% dividend yield is good. That is more than three times what the average S&P 500 company pays and well above the threshold to be considered a “high yield.”
What is a too-high dividend yield?
A too-high dividend yield refers to one that isn’t sustainable. A 10% yield coming from a highly leveraged growth stock isn’t the same as if it were paid by a REIT. To get an understanding of a too-high dividend yield, compare yields within sectors and check out the 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 stock. Each sector tends to trade at a different valuation and those vary over time. To find “average” dividend yields, compare yields within a sector and with the broad market S&P 500.