Understanding Dividend Yield is an Important Part to Investing Success

Understanding dividend yield is imperative because not all dividend yields are created equal, and some high dividend yields can be a warning sign


understanding dividend yield

The dividend yield is one of the most important ratios to understand when investing in stocks for income. Understanding dividend yield correctly can lead you to make better investments overall.

Before we get into the nuances of understanding dividend yield, let’s first define what dividend yield is. To calculate dividend yield, one must know the total of the annual dividend payments made per share. Take that number and divide it by the current stock price. The result will be the dividend yield for that stock. For example, let’s say a stock is $100 per share, and the dividend per share has held steady at 25 cents. 25 cents X 4 quarters = $1.00. Then $1.00 ÷ $100 = 0.01 for a dividend yield of 1%. 

However, that’s only the beginning of what an investor must know about dividend yields.

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Looking for companies that will provide you with consistent dividend yields

Some high dividend yields may be legitimate, and thus, an excellent target for investing in. There are certain parameters to follow when looking for these types of stocks.

Investors should first look at the historical dividend record. Has the company paid a dividend for numerous years? If so, how many? Finding a company that has paid a dividend for five to 10 years, and increased the dividend payments over that time are ideal candidates for investing in. Another consideration to make is how the company has performed during market downturns or recession. If the company has paid a dividend during such times, then it should receive strong consideration. This shows true profitability and stability. Companies that fit into this category are likely industry leaders or have a strong position within their industry. These types of companies often work as promising targets for long-term investment opportunities, and they can lead to income growth for years.

Furthermore, it’s worth considering the organization itself. Is it a brand you know with a strong reputation? Has the company grown over the years, and is it able to change with the marketplace? It’s even better to find information on the management when possible. Investing in a company with a successful management team that has led innovation and growth is a stronger investment than a company whose leadership continually changes and has a hard time engaging with a changing market.

Understanding dividend yield for income investors 

Income investors target dividends because they are proof of a successful, profitable business. There is no way to fake dividend payments. Companies that pay dividends have the means to do so, and that in itself is a sign of investment quality.

Income investors who buy dividend-paying stocks invest in some of the market’s best companies, assuming that the dividend yield isn’t too high. In fact, high dividend yields may be a warning sign for savvy investors to stay away.

Understanding dividend yields to be wary about 

Extremely high dividend yields can be problematic. Some stocks may offer a high current dividend yield that is unsustainable. If investors notice a high dividend yield from a company without a historical record of dividend payments, a certain level of skepticism may develop. That skepticism would question whether or not the company can maintain or raise its dividend in the future.

If a dividend cut then takes place and the company begins paying a significantly lower dividend, or no dividend at all, then investor confidence may wane. This, in turn, would lead to current investors selling the stock because its stock price would likely drop. This is a major reason why it is essential to understand the historical record of a company’s dividend payments, while also being aware of the company’s sustainability and growth within its industry.

What industries do you target when looking for stocks with robust and reliable dividend yields? Do you currently hold any stocks that have been historically paying dividends for five or more years?

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Stock investing is not an exact science, and common mistakes can cost you a lot of money. Avoid these pitfalls—revealed in this FREE report, Five Mistakes to Avoid When Stock Investing.

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