A dividend yield is an important financial ratio that tells us how much a company pays out in dividends as compared to its market share price. It is calculated in percentage terms and offers insights into return for investors as compared to a share’s market price.
Investors and analysts can use the dividend yield to analyze the financial performance of a company. It gives an indication of a company’s investment plans as well as dividend policy. It can also be used as a performance benchmark for a company for historical comparison.
A higher Dividend yield is preferred by investors. Although a high dividend yield is not a bad idea, its interpretation must be carefully done. You’ll need to appraise the company’s performance and look at the bigger picture before investing.
Let us get through the concept and see what is a good high dividend yield percentage for your investments.
Dividend Yield – Definition
The dividend yield is calculated by dividing the dividend per share by its market share price. It is denoted in the percentage terms.
For investors, a return can be in the form of dividends or capital gains. Measuring capital gains is usually associated with share price appreciation. Similarly, measuring the dividend gains is calculated through different financial ratios such as dividend yield.
The formula to calculate the dividend yield is:
Dividend Yield = (Dividend Per Share ÷ Price Per Share) × 100
The dividend yield ratio is presented in the percentage form.
What is a High Dividend Yield Percentage?
When measuring returns through dividends, a high dividend yield is preferred by many investors. Established companies with fewer reinvestment and growth needs tend to pay higher dividends. Thus, an established company is more likely to pay a higher dividend yield as compared to newer and growing companies.
A dividend yield of 5% and above is usually considered a high percentage. However, there will be stocks paying a dividend yield in double figures. Several factors contribute to the dividend yield percentage. One of the important factors is the share price. If a company’s share price falls, its dividend yield will rise and vice versa.
It is important to note that a dividend yield percentage for individual stocks will be different from those of Index funds, mutual funds, and ETFs.
One way of analyzing a dividend yield is to compare it with industry benchmark return rates. For instance, if the US Treasury rate is around 1.5% (currently), then dividend yield above 3% would be considered a high ratio. You can also compare the yield ratio against some of the top indices. For instance, the S&P 500 offers a historic yield of around 2%. Anything above these benchmarks will also be considered on the higher side.
Understanding a High Dividend Yield Percentage?
A higher dividend yield would mean a higher annual return on investment. However, that is not the case always. It is important to consider different factors before investing in high dividend yield stocks.
Stocks with high dividend yield percentages are stable. These companies come with a long working history and pay consistent dividends. Unlike, growing companies that pay a one-off high dividend, these companies maintain the financial ratios consistently.
High dividend yield stocks are also established and mature firms. These companies come with accumulated profits and cash assets. If these companies make large dividend announcements, it means they can afford it through cash without borrowing.
Paying high dividends also gives positive signals to the stock market. It means, in economic recessions, these companies will show resilience in terms of share prices through strong performance indicators such as a high yield dividend percentage.
Investors and analysts favor high dividend yield percentages from established companies. For instance, value investors consider these stocks to be undervalued. Thus, they take advantage of investment opportunities in these stocks to make good profits.
Which Companies Pay High Dividend Yield?
Generally, established and mature companies pay a higher dividend yield percentage. However, that is not the case always. Some companies manipulate their growth to present attractive financial ratios. A company with a declining share price will always show a higher dividend yield ratio.
Specific sectors and types of companies also tend to offer higher dividend yields. For example, Real Estate Investment Trusts (REITs) always pay higher than average dividend yields. Similarly, master limited partnerships and business development companies pay higher dividend yields.
Important Considerations with High Dividend Yield Investments
Investors must carefully evaluate the tax implications of a higher dividend yield. Ordinary dividend income is treated as regular taxable income. Dividends from certain segments such as REITs and MLPs are not taxed as capital gains. Thus, as investors look for higher dividends, they must also consider the tax implications with higher income.
If a company is paying lower dividends, it doesn’t mean it is performing badly. Some companies prefer growth over dividends. That in turn benefits shareholders through capital gains in the long run. Most growing companies pay no dividends at all as they retain profits for expansion projects.
When investing in high dividend yield stocks, you must consider the cash position of the underlying stock. Companies pay dividends out of their cash reserves. Sometimes, profit-making companies face liquidity issues that they cannot afford to borrow for dividend payments.
Another way of analyzing the performance of a stock is to consider its forward and trailing dividend yields. A forward yield is a forecast or prediction of its next dividend yield ratio. Whereas a trailing dividend yield is a company’s actual dividend-paying history. Analyzing these ratios will give you an idea of the stability and consistency of a company with its dividend policy.
Unlike a common notion low dividend yield is not always a bad signal. For instance, established companies may face a cash crunch during economic recessions. They’ll lower dividend payments and hence will offer a lower yield than their historic performance.
As an investor, it is important to evaluate the dividend policy of a company in a broader context.
Advantages of High Dividend Yield
High dividend yields offer good advantages to investors and analysts for the performance appraisal of stocks.
- High dividends yield comes from matured, established, and stable companies.
- Investors enjoy higher returns for their investments.
- Value investors consider these stocks as undervalued and can take advantage of quick gains as well.
- These companies show resilience in economic recessions.
- Investors can take compounding benefits by reinvesting these high dividend payments.
- The consistent dividend yield is a good measure of the performance appraisal for a company. It is one of the key financial and income ratios.
Disadvantages of High Dividend Yield
As we have discussed above, a high dividend yield is not always good. It offers some disadvantages and limitations to investors.
- High dividend yield can be misleading if share prices are declining.
- Companies often use high-interest borrowings to pay dividends that eventually raise their cost of capital.
- A high dividend yield also means the company is not reinvesting its profits efficiently.
- A high dividend yield alone cannot be used as a good performance metric of a company.
- A higher-than-average yield with a sudden hike can be an indication of volatile stock performance.
A high dividend yield is a good performance appraisal metric of a stock. However, investors must carefully interpret the yield. Broader economic factors, a company’s recent history, cash reserves, and a consistent dividend yield are all important factors to consider while evaluating the dividend yield of a company.