A high dividend yield is one of the most misread numbers available to a new investor, because it looks like a reward and is often a warning.
In short
- Yield is a fraction. It rises when payouts rise and when prices fall.
- Look at the payout in currency across several years, not the percentage today.
- Check whether profits and cash actually cover the payout.
- A yield far above everything around it is a question, not an opportunity.
A fraction has two halves
Yield is the annual payout divided by the current price. It rises when the payout rises. It also rises when the price falls, and it rises fastest when the price falls hardest.
So the same number describes a company paying more and a company the market has decided is worth less. On a screen they are indistinguishable.
The same number describes a company paying more and a company worth less.
How to tell them apart
- Look at the payout in currency, not as a percentage, across several years.
- Look at the share price over the same period.
- If the payout held steady while the price fell, the market is worried about something. Find out what.
- If the payout has been cut before, treat the current one as provisional.
| What you see | The good case | The warning case |
|---|---|---|
| Yield | Rising | Rising |
| Payout in currency | Growing year on year | Flat, or cut before |
| Share price | Rising more slowly than the payout | Falling |
| Covered by cash | Comfortably | Barely, or funded by borrowing |
Can they keep paying it
Compare the dividend to profit, and then to cash from operations. A payout comfortably covered by both is in a different position to one that exceeds either.
A dividend funded by borrowing or by selling assets is a dividend on borrowed time. Where to find these figures is covered in how to read an annual report.
Context beats the absolute number
Yields differ enormously between sectors and between markets. In an economy with high interest rates, ordinary yields are higher across the board, and a figure that looks generous elsewhere may be unremarkable there.
Compare a company to its own history and to its direct competitors. A yield that stands far above both is telling you something, and it is rarely that you found free money nobody else noticed.