Dividend Yield For A Good Night’s Sleep
Don’t you love it when life is black and white?
Well, it doesn’t get much blacker or whiter than when it comes to dividend yield.
The number is the number… end of story.
Well, almost the end of the story. That’s because I’d like to share a couple of important things to know about dividend yield. Then I’ll show you how you can use this to make more money with your stocks.
What is dividend yield?
It’s a simple percentage… a ratio. It’s how much a company pays out in dividends each year in relation to the price of a share of stock.
The simple calculation to come up with the yield: annual dividends per share divided by price per share.
Let’s say you buy a stock on January 2nd and at the end of the year, on December 31st, the share price is exactly the same as what you paid.
Your return on investment for the stock will be the yield. The only money you make is through the dividends.
Anything you make with the share price going up is gravy, and has nothing to do with yield.
Got it?
OK… let’s look at how much this yield should be. You’re doing some dividend stocks research and you see yield listed for the stock.
You run into yields all over the ballpark, and you even see stocks that don’t pay any dividends at all, so there is zero yield.
What’s the story on zero yield and no dividends?
Well, one of two things is happening. One scenario might be OK, but the other is trouble.
Scenario #1 – Let’s say the company is making money. If it wanted to, it could pay a dividend, but it decides not to. The company figures its investors are better off if profits are plowed back into company.
Maybe the money pays down some debt, buys back shares, builds a new factory, funds an acquisition, or goes into an investment in research.
Each one of these is fine, and could mean investors will be rewarded down the road.
Scenario #2 – The company’s not making money. There aren’t any profits to pay a dividend.
Well, that’s definitely not good. Investing in companies that lose money is how you lose your own money.
And here’s something else that’s not good. Sometimes a company will pay a dividend but the money doesn’t come from current earnings. Maybe the company dipped into savings, or sold an asset to come up with the cash to pay a dividend.
That’s about as clear a warning sign as you can get.
More Dividend Yield Basics
Let’s say you’re looking at two stocks.
Each one pays the same annual dividend of $2 a share.
Stock A trades at $40 and stock B trades at $80.
You get a better deal with Stock A. You’re paying half as much for the dividend. This means the yield is twice as high.
Your yield with Stock A is 5% and your yield with Stock B is 2.5%.
You’ve probably figured something out from this exercise… when a stock’s price slides, and the dividend stays the same, the yield goes up.
And vice versa… when a stock’s price goes up, and the dividend stays the same, the yield goes down.
Is the yield going down a bad thing?
It depends. Maybe the reason the stock price is on the way up gives the company a good reason to increase the dividend.
And if the company doesn’t increase the dividend and the yield goes south, all is not lost. You still collect the dividend, and you’re ahead of the game with capital gains.
Something Else Good To Know About Dividend Yield
Now you see how yield can bounce around. You understand the simple arithmetic involved, so you know that yield is not a good way to judge the strength of a stock.
You can have a company that’s in trouble, maybe because of a lousy earnings report, where the stock price is plunging. All kinds of financial warning lights are flashing. Key executives could be bailing out, strategic assets are being sold at fire sale prices, but the dividend yield is still strong.
Clearly, this is a misleading number. The yield is also likely to change, because a company that’s in trouble is probably a company that’s going to cut the dividend.
Never look at dividend yield in a vacuum. Line it up alongside other numbers. Put the yield in focus by seeing what’s been happening with the share price. Check out the latest financials to see if the company is making money.
If the company is in the black and making money, find out how much of its profits management decides to carve out to pay the dividend.
This is the dividend payout ratio… the percentage of profits investors are paid. Be suspicious when this number creeps up over 50%. This usually means the company’s not doing a good job paying down debt or investing for the future.
The exception to this rule is with a Real Estate Investment Trust (REIT).
By law, a REIT can only invest in real estate. And the company doesn’t have to pay any income taxes if it pays out at least 90% of its earnings in dividends.
High Yield Dividend Stocks Can Break Hearts
It’s not like shopping for a Certificate of Deposit where the highest rate wins. Those rules don’t apply.
When it comes to stocks, the higher the yield, the higher the risk.
Find out why in my article, High Yield Dividend Stock Disaster.
Don’t be surprised when the stock with the high dividend yield, yield that’s up over 10%, comes crashing down to earth once the dividend has been cut. It’s one of those death and taxes events you can bank on.
And there’s something else you can bank on in the world of high yield dividend stocks…
High Yield Stocks Can Throw You Some Knockout Punches
When the stock goes down, it can go down quickly. Sharp plunges aren’t unusual.
Here’s an easy way to see this.
You know what an ETF is, right?
It’s a security that tracks an index fund or a basket of assets. It trades just like a stock.
Because there seems to be an ETF for just about everything, naturally there’s one built to give you high yield income. It’s the Guggenheim Multi-Asset Income ETF $CVY.
This ETF doesn’t just track high yield dividend stocks. It also tracks a high yield basket of preferred stocks, REITS, Master Limited Partnerships (MLPs), closed end funds, and global stocks. Quite a hodgepodge, isn’t it?
These days, the yield for the Guggenheim Multi-Asset Income ETF is 5.5%.
But check out the last three years. See the setbacks? Notice how sharp the downturns are?
See how the ETF actually wound up a loser in 2014?
That’s the nature of the beast. You just can’t expect to invest in high yield dividend stocks and enjoy slow, steady growth. It’s going to be choppy.
The Yield That’s A Shield
The dividend yield that will shield you from serious trouble will be less than 10%. The yield that shields you from the sharp ups and downs of volatility and gives you a good night’s sleep is usually less than 4%.
What kind of yield makes sense for you?
Work the number backwards from your own investing objectives, and your own thirst for risk.
Don’t chase yield. Don’t size up a dividend stock on yield alone.
And don’t forget to look to see where the money being used to pay the dividend is coming from.
That’s how you make great investments in solid dividend stocks.
Regards,
Michael Jennings
Dividend Stocks Research
Note: Michael Jennings writes and edits DividendStocksResearch.com. Sign up for our free dividend reports and dividend newsletter at http://www.dividendstocksresearch.com/free-sign-up. We’ll show you how to create regular income by investing in dividend stocks, easily, step-by-step.
Category: Dividend Stocks
