What is a high dividend yield? Are they really that great? Are they worth the money? So many questions!
What is a high dividend yield? It’s a blessing. And a curse. But to understand these blessings and curses, it’s best to start with a story. That story is of the ancient king Midas.
According to the myth, the god Dionysus offered to grant Midas a wish as a reward for his hospitality. Midas, already a wealthy king, loved gold, and so his wish was that everything he touched would turn to gold. While this started well enough, Midas soon realized his greedy desire had a dark side. He couldn’t eat or drink because all the food and wine he picked up turned to gold. Misery turned to despair when he hugged his beloved daughter, and she turned into a gold statue.
Midas is able to reverse the curse, but there are a few lessons to be learned here. Be careful what you wish for, don’t be greedy, and there is such a thing as too much of a good thing. While Midas’ stores of gold were good, his desire for even more gold quickly turned into a curse. Such is the case with stocks that have a high dividend yield.
What is a high dividend yield, anyway?
Let’s start with a few quick definitions. A dividend is a cash bonus you get for owning a stock. More specifically, it’s a share of profits the company gives back to shareholders. These dividends can increase, decrease, hold steady, or even get suspended. It probably goes without saying that better, more profitable stocks are the ones who increase dividend payouts, and vice versa.
A dividend yield is that dividend as a percentage of the share price. Here’s a hypothetical example: A $10 annual dividend on a $100 stock would give you a 10% dividend yield. Assuming the dividend didn’t change, and the stock price rocketed to $200 per share, your dividend yield is now 5%. On the other hand, if the stock price drops to $50 per share, your dividend yield goes up to 20%.
Clearly, a higher yield isn’t ideal in this situation, just like more gold wasn’t ideal for King Midas. But here’s another scenario. You have two different stocks. The share price of both is $100. One has a 5% dividend yield, and the other has a 10% yield. Assuming other factors are relatively similar, that higher yield stock looks a lot nicer.
Of course, you know that nothing in the investing world happens in a vacuum. There are plenty of great companies out there that have minimal dividend yields, or may not pay a dividend at all. And as you can see, a sharp drop in stock price can give you a higher yield, although that could well disappear if a company is in real trouble.
That said, there are some stocks with high dividend yields that are great additions to any portfolio. In terms of numbers, however, what is a high dividend yield? Some of the highest dividend yields on the market range from around 3% to almost 9%, although Yahoo! Finance reports that the average dividend yield in the S&P 500 is about 2%.
How to find the best dividend stocks
What is a high dividend yield if not a great tool for finding dividend stocks? If you’re after dividends (and it’s always good to have at least some dividend stocks in your portfolio), dividend yield can be an excellent place to start your search.
Real Estate Investment Trusts (REITs) tend to offer steady, high dividends with relatively low risk. You could also look at the Dividend Aristocrats or a Dividend Aristocrats ETF, the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). The Dividend Aristocrats are a select group of companies that have increased their dividends every year for at least 25 straight years. These are mostly household names like AT&T (T), currently yielding 7.02%, and 3M (MMM), currently yielding 2.91%.
There’s also another group of dividend stocks, known as the Dividend Kings. Stocks in this group have raised their dividend for 50+ consecutive years. As you can imagine, this isn’t a very large group of stocks. But again, you’ll find household names like Target (TGT), yielding 1.19%, and Sysco (SYY), yielding 2.33%. You’ll also find some classic and fun names here, like Tootsie Roll Industries, Inc. (TR), with a 1.07% yield, and Coca-Cola Co (KO), yielding 3.03%.
Clearly, these are not the highest yields around, which brings up the question of what is a high dividend yield truly worth to your portfolio? No, Tootsie Roll Industries won’t make you rich, but the company probably isn’t going anywhere. You could, in theory, sit back and let those dividends roll in without giving it too much consideration.
And AT&T does offer a nice yield, but the stock itself has been fairly volatile over the past few years. However, if you can ignore the volatility and hang on for the long term, there is some real potential for that dividend yield to contribute significantly to your coffers.
Remember, though, when you’re looking at stocks, even from select groups such as these, it’s important to balance your desire for yield against other qualifications. A high yield won’t do you much good if the stock price is continually sinking.
If you want the best dividend stocks right now regardless of yield, subscribe to our Cabot Dividend Investor advisory, where chief analyst Tom Hutchinson has a portfolio full of dividend-paying stocks that offer generous yields and strong share price growth.