What Is A Good Dividend Yield Percentage?

Popular dividend-paying stocks tend to be companies found in industries that enjoy high cash flows, and ones that aren’t encumbered with the obligation to reinvest their profits back into the business. These are more likely to be mature companies, particularly those in the utilities and consumer goods sectors.

What Is A Dividend Yield?

When gauging the value of a dividend paying stock, one of the more helpful metrics to consider is the dividend yield percentage.

The dividend yield percentage is a ratio that tells you how much a dividend is worth as a fraction of its current share price. The formula given for calculating the dividend yield percentage is:

Dividend Yield Percentage = [Annual Dividend per Share ÷ Present Day Share Price] x 100

So, for example, a company that pays a yearly dividend of $3 for each of its shares priced at $50 will have a dividend yield percentage of 6%.

The dividend yield percentage is a useful tool because it tells you how much income you can expect to receive on a unit cost basis.

For instance, if all you knew about two stocks, A and B, was that stock A paid an annual dividend of $5, and stock B $10, this wouldn’t tell you which stock returned the most income to you without knowing the current share price of both the companies’ stock.

Stock B might cost $200 per share, giving you a yield on that $10 of just 5% – whereas stock A, whose absolute dividend value is less, might trade at $20 per share, returning a much higher yield of 25%.

And remember – don’t confuse the dividend rate with the dividend yield, as some sources use these terms interchangeably. The dividend rate is just another name for the total annual dividend payout in dollars – similar to the $5 and $10 examples in our scenario above.

What Is A Good Average Dividend Yield?

All other things being equal, a higher dividend yield percentage is normally more favorable for an investor, because, as a dividend yield increases, the returns a shareholder receives per share are maximized. However, as with most things in life, things are not always so simple.

The problem that investors run into with higher yielding dividends is that the growing yield can be indicative of underlying issues afflicting the stock. For instance, if you refer to the formula used for calculating the dividend yield, you will notice – assuming that the annual dividend rate remains the same – that, as a company’s share price drops, its yield grows higher.

As good as this might be in the short-term, a business that’s losing market capitalization is usually a business that is failing. And a failing business – one that’s not producing any profit or significant cash flow – is one that isn’t going to keep on paying out a dividend.

For an income investor, this makes holding the share pointless. Yes, you might be able to take some gains for a short while, but once the dividend is gone the stock is essentially worthless from an income perspective.

Is A 5% Return Good?

The traditional wisdom states, with good reason, that a stock that gives a dividend yield percentage of around 4-6% is likely to be a safe and reliable dividend, and one with a high enough yield to make it worth investing in. 

As income investors know, one of the most powerful strategies of dividend investing is having the ability to reinvest your dividend payout back into the company again, thus compounding the return you receive from the stock over time.

Indeed,research has shown that investing $10,000 in 1960 in the S&P 500 would have returned $3,845,730 to those investors reinvesting their dividend payments over the intervening period, compared to a total of just $627,161 to investors whose returns were based purely on the index price alone.

Is A 10% Yield Good Or Too High?

Although rising yields can be a sign that something’s fundamentally wrong with a company, that’s not always the case. In fact, high yielding dividend stocks can make for excellent hedges when a market is particularly volatile, or interest rates are climbing at unusually high amounts.

However, caution is always advised when a yield seems too good to be true. A company that isn’t well-established – or doesn’t appear to have a solid business behind it – but is still paying a high yield dividend, is quite often one to be wary of.

Some stocks will try to attract investors through a large dividend just to generate price action and liquidity for its shares. But a company that does this when it should be using its cash to grow its operations and expand its business is one that is probably worth avoiding.

Round-up: What Is A Good Dividend Yield Percentage?

While the dividend yield percentage is a good yardstick with which to evaluate a dividend paying stock, it is by no means comprehensive. There are many other indicators that should inform your decision whether or not to buy a dividend stock.

The dividend payout ratio, for example, is another important metric, since it gives you a figure for the total amount of cash that a company is using to fund its dividend payments compared to the net income that the company makes. 

Furthermore, some high yield investment vehicles – such as real estate investment trusts (REITs) and business development companies (BDCs) – will issue dividends that are subject to different, and sometimes higher, tax rates than in ordinary circumstances – which might erode your expected profit margin at the end of the day.

Dividend investing is a great way for you to grow passive income from your stock portfolio, and the dividend yield percentage is an invaluable tool in determining which companies you should buy. Don’t be charmed by high yielding companies that may come with some underlying risks; instead, look for quality businesses offering a good yield and a safe dividend, ones that will continue to compound over many years to come.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.