How To Evaluate Higher Dividend Yields
The dividend yield is one of the first metrics stock investors look for. Thus, I want to address an important question: is high dividend yield good or bad?
Since dividend yield is very important. For anyone interested in making money from dividends.
And when we are done. You will be better equipped to know when a high dividend yield is good. And when it is not.
So, let’s get moving…
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
Is High Dividend Yield Good Or Bad?
A high dividend yield is good when a company whose stock pays a dividend…
- Has a strong history of making regular and recurring dividend payments
- Maintains an acceptable dividend payout ratio
- Operates a business that can survive difficult economic times
Conversely…
A high dividend yield is bad when a company does not possess a strong historical dividend track record. Nor does it have the business model and financial resources in place to sustain the dividend into the future.
This is when dividend safety comes into question.
Because absent the key elements noted above, future dividend payments may be at risk of being reduced or suspended. When this happens, it typically takes the stock price down with it.
Thus, reducing the investor’s future dividend income. Wiping out your capital gains. And generating capital losses.
Next, I’d like to dive further into the answer to this question. Using Altria stock (NYSE: MO) as an example.
So, stick with me here, for right now. Then, before you go, check out our library of…
Dividend posts and related resources
Example Of When High Dividend Yield Is Good
For several years, Altria’s dividend yield ranged between 7%-9%. And most investors would agree this is a high dividend yield.
In my opinion, it is also a good dividend yield.
So, let’s see why I say this. By evaluating it against our criteria for suggesting when a high dividend yield is good. Versus when a high dividend yield is bad…
1. A Strong Dividend History Makes For A Good High Dividend Yield
First of all, Altria has an impressive dividend history.
Since the company started paying regular and recurring cash dividends back in the 1960s.
Furthermore, Altria is a Dividend King.
Dividend Kings are elite companies with an increasing dividend rate per share. Having done so for at least 50 years in a row.
There are only a few dozen of these stocks in existence. And their management will typically go to great lengths to protect such an honor they have earned.
So, our first criteria for determining whether a high dividend yield is good or bad has been met. It’s hard to argue with Altria’s top-notch historical dividend track record.
You can find other high dividend-yield stocks. With solid historical dividend track records. It just may take a little digging to do so.
Next, good high dividend yields are supported by an acceptable dividend payout ratio. Furthering our case for when a higher dividend yield is better.
Let’s discuss…
2. An Acceptable Dividend Payout Ratio Indicates A Good High Dividend Yield
The dividend payout ratio tells us how much of a company’s financial resources are being paid out to shareholders as dividends.
First, by taking the dollar value of dividends paid. And dividing it by the company’s financial resources, you get the dividend payout ratio.
Further, the calculation gets a little tricky when deciding what measure of a company’s financial resources should be used.
The primary options include:
- Accounting earnings
- Adjusted accounting earnings
- Free cash flow
- Funds from operations (for real estate investment trusts)
Any of these options can be useful. It depends on the company and the industry in which it operates.
Finally, an acceptable dividend payout ratio requires judgment on the part of an investor too. Because what may be acceptable for one company. May not be for another.
One thing can be said for sure. A lower dividend payout ratio is generally better. For example, less than 60% is considered a solid level.
But that doesn’t automatically mean a higher dividend payout ratio is bad.
Let’s continue our example of when a high dividend yield is good. Looking at Altria…
Management has indicated that they target a dividend payout ratio of 80%. Using adjusted earnings as their preferred measure of financial resources. And from my review, Altria’s adjusted earnings closely resemble their cash flows.
So, is an 80% dividend payout ratio for Altria acceptable? I believe it is.
Because they have a consistent demand for their products. They have shown the ability to raise prices. And their business requires limited capital investment.
Thus, allowing management to allocate large sums of cash for dividends.
You may have noted I mentioned the word “consistent”. Let’s talk about that next…
3. A Stable Business Model Separates Good High Dividend Yields From Bad
Because business consistency and stability are critical for supporting a high dividend yield.
Since regular dividends repeatedly require cash. Thus, the cash generated from a business can not be subject to unpredictable swings in business performance. No matter the economic environment.
This is why we often see stocks that pay dividends. Operating in mature and stable sectors of the economy.
Providing goods and services that are resistant to sudden and unpredictable decreases in demand. As a result, dividend-paying companies usually operate in industries like these…
- Packaged foods
- Household goods
- Electricity and natural gas
- Real estate investment trusts
- Technology products and services
So, continuing our example of high dividend yield stocks with good dividends, what about Altria?
Yes. The company operates in the tobacco industry. Where long-term demand for their legacy products is declining.
On the other hand, the decline is steady and predictable. Allowing management a high degree of certainty as it decides how much of the company’s financial resources to allocate for dividends.
Are high dividend yields good? Well, I think they can be.
Making the extra dividends received worth it. And Altria illustrates why I think so.
So, I mentioned that Altria’s legacy business is in decline. That needs to be addressed. Bringing me to a final point.
As we discuss whether a high dividend yield is good or bad…
The Risks Involved That Make Some High Dividend Yields Bad
Investing in high dividend yield stocks has risks. Unfortunately, we aren’t talking about free money here.
And high dividend yields are always high for a reason. Since the collective minds of investors in the stock market are telling us something.
Because investors are saying there are greater risks involved. So, here’s why you may not want to buy dividend stocks with high dividend yields…
In the best case, the risk is the company will be unable to grow profits in the future. Thus, we have a stock that will unlikely rise moving forward. Nor will management be able to significantly increase its dividend rate per share with stagnant growth.
Or, in the worst case, the future of the company’s dividend is very uncertain. Meaning management may be forced to reduce or suspend the stock’s dividend.
Thus, causing losses for dividend investors. No matter how much cash is received in dividends.
Okay. That concludes my thoughts on some of the pros and cons of high dividend stocks.
So, allow me to conclude with a few parting thoughts…
Wrap Up: Is A High Dividend Yield Good Or Bad?
Is a higher dividend yield better? Well, it can be for making the most dividends possible. But, not always.
I believe a high dividend yield is good when the company that pays it has…
- A history of regular and recurring dividend payments
- An acceptable dividend payout ratio
- Business operations in a stable industry
Furthermore, to evaluate dividend stocks, I use the Simply Investing Report & Analysis Platform. It’s a great tool to help me get to the bottom of today’s big question…
Is high dividend yield good or bad? Based on today’s discussion plus some help from Simply Investing. You are better equipped to decide for yourself.
More Reading About Dividends And Dividend Stocks
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all of our dividend investing articles
… to level up your dividend investing game!
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.