Last Updated on 21 November, 2023 by Samuelsson
It turns out history gives us some good clues about what is a good dividend yield. If you’re a dividend investor, it certainly tells you where you should concentrate your investment research. While Treasury yields have decreased, many dividend investors have gravitated to invest in higher-yielding stocks. But keep in mind that a dividend is no substitute for a coupon. Thus, it’s relevant to ask: what is a good dividend yield? What is a safe dividend yield? Is a high dividend yield good?
The fact is that a good dividend yield is neither high nor low. If you’re a dividend investor you should look for a stock that has an average dividend yield – not high and not too low either. Research shows the lowest and highest quintiles of dividend-paying stocks underperform those in the 2-4 quintiles.
What is the dividend yield?
A dividend yield is a percentage that expresses the annual dividend concerning its stock price: the annual dividend payment divided by the share price.
For better understanding, let’s assume that a dividend is neither raised nor dropped, the yield will rise if the price of the stock were to fall.
In the case where the value of the stock rises, the yield will fall. This understanding goes a long way in realizing what really is the dividend yield.
In general, new companies that are still growing but are comparatively small don’t pay high dividends as much as mature companies do.
Also, mature companies that aren’t growing too fast tend to pay high dividend yields. These two statements show the direct relation that dividend yield has with the growth of the company.
There is a good reason why experienced investors say no to chasing after high yields when investing in dividend stocks. The higher the dividend a company pays, the less it invests in itself.
Moreover, dividend yield does not provide enough information. A high yield may have a lower stock price and reap the same benefits as the high-priced stock with a lower dividend yield.
In fact, experts generally suggest a yield that isn’t too high or too low is the best:
What is a good dividend yield?
So, what is the best dividend yield?
Research by Hartford Funds, for example, in a study called The Power of Dividends, shows that the lowest and highest quintiles underperform the 2-4 quintiles, with the fifth being the worst.
And which yield group is in the fifth quintile? It’s the 20% highest-yielding stocks. This, to make a generalization, is not the group of stocks where you want to invest. In other words, among the dividend-paying stocks, the worst group is the group with the highest dividend yield.
Likewise, you would not look for dividend stocks in quintile number one, the group with the 20% lowest-yielding stocks. They are the second worst-performing quintile. The best dividend stocks yield the closest to the average, in quintiles 2-4.
Why? Let’s take a look.
Why you should not chase high dividend yield
A high dividend yield does provide an attractive number that attracts a lot of investors.
But the ones trying to construct a robust portfolio have a lot depending on dividend yields since it directly depends on the company’s growth. Here’s why a high dividend is not always a good deal.
The company may be in trouble
Not every time a high yield is a good sign. Yes, dividends represent generosity on the company’s part for the trust an investor is putting in the company, but equally high yields represent potential risks.
First, a company pays dividends out of its net income or retained earnings, meant to be invested in the company’s growth for its current and future projects with potentially high returns. So like we have said before, every penny a company is paying in dividends is every penny they are not investing in future growth. Many companies could pay a dividend but chose not to.
Moreover, a high dividend yield mostly occurs when the share price falls. Why does the share price go down? It goes down because the market discounts future problems and estimated deteriorating earnings.
A perfect example is the drop in Altria from 75 in mid-2017 to below 40 for most of 2020.
However, the earnings have not fallen, and the dividend is not cut, but somehow the market discounts a bleak future for Altria. It’s up to you as a dividend investor if you believe this is for real or a good buying opportunity.
Dividend yield misconceptions
Many investors in the run for chasing high yields forget about the stock price. A high-valued stock with a low dividend yield may benefit the same as a low-valued stock with a high yield. For someone looking forward to saving for long-term goals needs to focus on total returns, the stock’s valuation, and the payout ratio.
It is troubling when investors focus on just the stocks’ dividend yield, thinking of them as bonds. In fixed-income investments like bonds, the yield is the return. However, it is not the same for a dividend stock. Moreover, dividend payout is not compulsory for a company to pay, it is more like a distribution.
Always keep in the back of your head that you can sell shares to get “income”.
Wrong evaluations based on dividend yield
It is highly recommended that investors not evaluate the data based on just its dividend yield. The data could be old or based on misleading information. There are instances of many companies that have a very high yield because their stock is falling.
If a company goes through a secular decline, there’s a high possibility that it cut down the amount of the dividends or even eliminate them completely.
In fact, investors should take extra caution while analyzing a company in distress with higher than normal dividend yields because stock price is the denominator on the estimated future earnings.
What is a good dividend yield? Conclusion
For long-term return, an investor should look into the company’s growth instead of just focusing on the dividend value. At the end of the day, the dividends come from earnings and cash flows. Thus, always focus on the long-term prospects of the company!
An experienced investor knows the value of total return and inclines towards compounding. Investing back into the company with the dividend amount increases their total return. Looking into dividend yield is important and, at times, beneficial; however, it is always smart to dig a little deeper.
So, to sum up, what is a good dividend yield? Evidence suggests going after an average yield- not too high, not too low. Chasing a high dividend yield is mostly not a good idea!
FAQ:
– Why is it important to consider dividend yield when investing?
Dividend yield is crucial for investors as it provides insights into the income generated from their investment. Understanding how to interpret and evaluate dividend yields helps in making informed investment decisions.
– Is a high dividend yield always good for investors?
Not necessarily. While a high dividend yield may seem attractive, it can signal potential risks. A company with an exceptionally high yield might be in financial trouble or experiencing a decline in share prices, impacting future growth.
– What is considered a good dividend yield?
Research by Hartford Funds suggests that the best-performing dividend stocks are those with yields closest to the average, typically in quintiles 2-4. It indicates that a moderate dividend yield, neither too high nor too low, is often a prudent choice.