How High Is A High Dividend Yield?

For an investor looking to supplement an income, companies that pay a high dividend yield wil be very attractive.

It is vital for an investor to recognise that everything is relative. A high dividend yield can only be 'high' relative to the payments from other companies. These payments can be compared to other companies in the market as a whole, in the same sector (builders, for example) or from the same part of the index (FTSE 100 companies, for example, are regularily compared against each other, purely due to size rather than any similarities in industry or business model).

This means that for an investor to make such a comparison, they must have access to the other pieces of relevant data. This can be either a very time consuming job, or alternatively, simply a case of downloading the relevant information from a market info provider.

There are, of course, mutual funds and unit trusts that specialise in hunting out the big payers.

Follow the money

It is worth noting that it is often, though not always the case, that a firm that makes above average size payments will also have a strong cash flow. The above average payments are often made possible by the strong cash flow. It also follows, that such companies are probably more profitable many than others.

Therefore, it can be argued that firms who pay a high dividend yield are worthwhile as investments for a number of reasons. It goes without saying though, that individual research should always be carried out before an investment is made.

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Such companies, with strong cash flows, good levels of reliable profits, that pay a juicy annual dividend are often referred to as being 'defensive. This means that they are often not high growth, fast price rising firms, but instead, when all else fails and the economy is going wrong, they will still be making lots of money day in and day out. They are reliable, and in investment, there is a lot to be said for that!

Please note that the dividend yield being paid by a company is relative to price. This means that as the stock price moves, so does the yield. The numbers actually move opposite to one another. Therefore, as the market price increases, the annual dividend is worth less as a percentage.

How high is high?

However, this means that strong, solid companies which pay high dividends can be bought for very acceptable prices when the market generally is falling. Not only can these companies - or their stock - be purchased at favourable prices, their annual dividend will be worth far more than was previously the case because of the drop in price.

Since company management teams are usually reluctant to cut the amount being paid out to shareholders, these steep price falls in big companies can offer excellent opportunities to investors, if the underlying business is still trading well.

In the first year or two of a new harsher economic reality, big companies that were paying out three percent per year might suddenly find that they are now paying out eight or nine percent. In the early 2000's, for example, your author can recall a number of banking stocks in the UK that were paying above ten percent per year. Of course, we know what happened to them...

Other related pages are:

To An Investor, A Dividend Is A Valuable Thing!

The Definition Of A Dividend

Dividend Policy And Dividend Cover

Understanding And Calculating A Dividend Yield

Building A Dividend Portfolio

How Does A Scrip Dividend Work And What Is A Scrip Issue?