If you’re new to dividend stock investing, you’d want to wrap your head around what a good dividend yield is. In this video, I’ll use real-world examples, including Johnson & Johnson (NYSE:JNJ), Apple (NASDAQ:AAPL), General Electric (NYSE:GE), and Simon Property Group (NYSE:SPG).
You’re probably interested in investing in dividend stocks if you’re here to learn about dividend yields and want to know what a good dividend yield is.
I’ll first explain what a dividend yield is, and what affects it. Then, I’ll follow with a super simple example as well as real-life examples, introducing some safe dividend stocks and their dividend yields.
Second, I’ll explain the difference between dividend yield and yield on cost and why they’re relevant to investors.
Third, I’ll give examples on what makes a good dividend yield, as you may be wondering if, say, a 5% yield is better than a 2% yield. I can tell you right off that that it’s not always the case.
Finally, I’ll recap the key takeaways at the end.
Dividend Yield Explained Simply
So, what is a dividend yield? Explained simply, it is the annualized dividend per share of a company divided by its current share price.
The dividend yield is important to you, the investor of a dividend stock because it determines how much income you’re expected to get if you invest a set amount of dollars in the stock right now — as long as the dividend stock continues to pay its current dividend
The dividend yield is important to you, the investor of a dividend stock because it determines how much income you’re expected to get if you invest a set amount of dollars in the stock right now — as long as the dividend stock continues to pay its current dividend.
Simple Example on Dividend Yield
For example, if a stock is $100 per share and it pays out dividends of $3 per share over a year, the dividend yield is 3% (calculated by $3 divided by $100).
If the stock price rises to $150 per share next year, and the stock still pays a $3-dividend over a year, the yield would drop to 2%.
However, as an aside, that’s not a bad thing because the shareholder got an awesome 50% price appreciation. And he or she can sell the shares for a profit that’s worth more than 16 times the dividend they’d get in one year!
Besides, if the stock price is doing well because of higher profits made by the underlying company, then, the price appreciation is well supported. In other words, it wasn’t a bubble that was created by speculators bidding up the stock.
Dividend yields are always calculated based on how much dividends (per share) a company is expected to pay out in a year and the current stock price of the company.
Don’t Chase High Yields; Avoid Dividend Cuts
Essentially, the higher the dividend yield, the more money you’ll get as a shareholder, as long as the dividend is sustained. To keep it simple, I won’t explain here what makes a dividend sustainable, but you can trust me that the dividend stock examples used in this video are fairly safe.
As mentioned earlier, the dividend yield of a stock equals the annualized dividend per share of a company divided by the current share price of the company. Therefore, if the company increases its dividend or its share price falls, the dividend yield will go up.
Likewise, if the company cuts its dividend or its share price goes up, the yield will fall.
Believe me, it’s super bad news if a company cuts its dividend. Ideally, you don’t ever want that to happen to any dividend stocks in your portfolio or you want to have exited the stocks BEFORE they cut their dividends. Because usually huge stock price declines come before dividend cuts or anticipated dividend cuts.
For example, before General Electric stock cut its dividends both times in the past its share price already started falling off a cliff. However, its dividend looks much safer for the next few years after the last dividend cut. Investors can’t just see GE as a passive income dividend stock but a cyclical, total-return investment.
Yield on Cost ≠ Yield
Here’s a much safer dividend stock. Johnson & Johnson currently pays a quarterly dividend of $0.95 per share while it trades at $150 per share. So, it yields 2.5%.
Note that your yield on cost is different from the dividend yield of a stock. While the dividend yield changes based on the changing stock price, the yield on cost changes based on dividend changes or the shareholder buying more shares and thereby changing the average cost per share.
Yield on Cost ≠ Yield: J&J Example
I bought JNJ shares at $121 in May 2018 when it paid quarterly dividends of $0.90 per share (or $3.60 per year). I added to my position and invested a similar amount again at $131 in November 2019 by which time the global healthcare stock paid dividends of $0.95 per quarter or $3.80 per year.
Assuming I bought the same amount of dollars both times, my average cost per share would be $126 (($121 + $131) / 2)
Therefore, my yield on cost is about 3%, while the yield of the stock is about 2.5% right now. As an aside, let’s not forget that I’m also sitting on unrealized capital gains of about 19% in a high-quality company.
The Best Dividend is a Growing Dividend
The best-case scenario is that investors continue buying shares of a winning company (when it’s attractively priced) and the company continues to churn out more profits and increase its dividend year after year. Then, your yield on cost will just continue to increase perpetually.
Imagine, years later, you have a yield on cost of 20%, which means, essentially, you’ll be getting a return of 20% based on the amount you invested years ago. And you’ll get this 20%+ return every year.
If Johnson & Johnson increases its quarterly dividend to $1 in April, then its annualized dividend would be $4 per share. And my yield on cost would be 3.1%.
What’s a Good Dividend Yield?
What’s a good dividend yield? First, the dividend needs to be safe and sustainable. Second, if you need income now (for example, you’re a retiree or you want to fund your annual vacations with dividends) you’d require a minimum yield from your stock portfolio.
What’s a High Dividend Yield?
The S&P 500 ETF offers a yield of 1.66% at writing. Lowell Miller, who is the author of the very popular book, The Single Best Investment, that focuses on creating wealth with dividend growth, prefers high yields that are at least 1.5 times the market’s, which in today’s case is a minimum yield of 2.49%.
Miller’s single best investment formula is as follows:
High quality + High current dividend + High growth of dividend = High total return
Johnson and Johnson passes the first two tests. It’s a triple A rated company, so it’s high quality. Its earnings are also very stable and recession proof.
Its yield of 2.5% just passes the high current yield test. However, for the high growth of dividend portion of the formula, Miller prefers a growth rate of 10%, while Johnson and Johnson will probably increase its dividend by about 5-7% per year.
Prefer a Growing Dividend Over a Stagnant One
A growing dividend is always more attractive than a stagnant one. Because a stagnant dividend may indicate there’s no growth for the company. Earnings or cash flow growth drives dividend growth and price appreciation.
Ideally, for a long-term dividend portfolio, you want a mix of dividend yields.
Typically, higher dividend yields offer immediate income + stable growth, while lower dividend yields offer some income but the focus is on higher growth.
Although Simon Property’s growth is estimated to slow to 3-4% per year over the next few years, long-term investors should be compensated with price appreciation of about 40% from P/FFO expansion eventually.
Simon Property would fit a retirement or income-oriented portfolio, which may aim for a dividend yield of 4-5% that’s growing dividends by 5-7% per year across all the holdings.
Investors focusing on growth may have a portfolio yield of 0-3% and aim for a growth rate of 10-20%.
A company’s dividend yield = its annualized dividend per common share divided its share price
Your yield on cost on a stock = The Annualized Dividend per share of the company divided by the Average Share Price You Paid
As share prices go up and down, the dividend yield of the stock changes. A higher price leads to a lower yield but also price appreciation. A dividend hike will increase the dividend yield, but if it’s a good company, the stock price should eventually follow to bring the yield down again.
As a company increases its dividend, your yield on cost will only rise, which is what we want to see. If you buy more shares, your yield on cost will change because your average cost per share changes.
A good dividend yield is one that provides you safe and sufficient income as well as adequate or high dividend growth. In general, a growing dividend is always better than a stagnant one.
Credits, Sources, & References:
Pixabay artists, F.A.S.T. Graphs, Google Finance
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Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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