Dividend (and dividend growth) investors have long debated on what is a good dividend yield. How little yield is too little, and is a high yield always better?
These questions and more are explored by contributor Andy Shuler, with a couple of great examples and data to back up his claims…
If you’re like me, when I first started listing to the Investing for Beginners Podcast, I had absolutely ZERO experience with investing. Sure, I took some finance classes in college, but that didn’t exactly focus much on dividends or investing, and even if they did, it’s now been quite some time without that being used in my daily life, so any knowledge learned at that point was completely gone from my brain.
Sure, the company that I work for issues a dividend, so I vaguely understood that money was being given back to the investors, but I had no idea if the right amount was being given back, or anything really that defines the purpose of a dividend.
So, as I listened to the podcast, I kept hearing Andrew and Dave talk over and over about dividends…and the power of the DRIP…and how they won’t really invest in a company unless it has a dividend. So, I started to research and try to understand dividends, and there’s a ton of information on the internet about them!
But, if you try to find what a good dividend yield is…you just can’t do it. So here I am. I’m going to tell you.
What is a good dividend yield, you ask? Well…
A good dividend is one that continues to increase its yield!
Let me guess – my answer bums you out a bit.
You were expecting a number like 8%! Or maybe even higher! Something just absolutely crazy. But, I cannot give an answer like that because each situation is different based on the company and the current market atmosphere.
For instance – Let’s pretend that I said 5% is a great dividend yield. Now, let’s say that Andy’s Baseball Cards (completely made up company but we will use the ticker ABC for this example) is priced at $100/ share. ABC historically is a very strong company that has increasing dividends, but they just lost $30,000,000 in 2018 and the outlook is looking much worse for the future years due to kids preferring virtual baseball cards instead of the paper kind that ABC makes.
The question now is, if you’re a long-term investor in ABC, and you see that ABC needs to make a huge change to their business and shift from paper cards to virtual cards, would you prefer that they continue to increase their dividend, even though they lost money last year, or cut back the dividend and try to right the ship?
Personally, for me, I would prefer that they try to make this overhaul and reduce the dividend to keep them from pulling on their cash/going into debt to fund the dividend. It really comes down to personal preference, but as a long-term investor and believer in ABC, I’d prefer to decrease the dividend to fund the investment for the major overhaul of the business.
High Yield Example: MLPs
A very popular group of companies that people seem to get attracted to when only looking at a dividend yield are Master Limited Partnerships, or MLPs. Sure, many MLPs do have strong yields (commonly 7% and higher)! But, you have to look at more than that. For instance, let’s look at PSXP:
Currently, the stock is offering a 7.04% dividend! BOOM! That’s crazy – sign me up all day for that. Right? WRONG.
Just because a stock has a high dividend yield, it might be a “good yield” but not necessarily a good investment. Since Q2 2014, PSXP has given back very strong dividends, but the stock also has dropped from $66 to $50.19 in that 5-year period. Personally, I would’ve rather just bought the SPY ETF that’s representative of the S&P 500. In the example below, I outline the share price 5 years ago, current share price, and total dividend. Total dividend is the sum of all dividends paid during those five years.
You might notice that the ‘Total Dividend’ is only $11.15 for PSXP but it is $22.89 for SPY, but you have to remember that the dividend yield is directly correlated to share price, so it’s an average dividend of $2.23 ($11.15/5 years) for stock that is now $50.19 for PSXP vs. the SPY average dividend of $4.58 ($22.89/5 years). To break it down further, if I took the average dividend yield (using the last 5 years of dividends and comparing it to current price) you’re looking at 4.44% ($2.23/$50.19) for PSXP and 1.59% ($4.58/$288.53) for SPY.
As you can see, if you bought one share of PSXP your total return (including paid dividends) would’ve been -7.06%! During that same time period your SPY return would’ve over 59%. That is an absolutely huge difference between those two stocks.
Below I’ve broken it out quarter by quarter, so you can see the exact quarterly dividend that you would’ve earned:
At this point, you might be confused – I’ve told you that dividends are good, but too much of a dividend might not be good, yet Andrew and Dave won’t invest in stocks without a dividend – SO WHAT THE HECK IS A GOOD DIVIDEND???
Well, I’m going to revert back to my first answer. The correct answer to this question is a dividend that continues to grow. A growing dividend is a good dividend, but it is possible to have growing dividends in bad investments, as I just showed.
The ideal goal is to find a good, growing dividend in a strong, undervalued stock.
To accomplish this, I’d recommend taking a look at the Dividend Aristocrats. To qualify as a Dividend Aristocrat, you have to be a member of the S&P 500 and have increased your dividend for 25 consecutive years.
Currently, there are 57 members in the Dividend Aristocrats including household names such as 3M, Caterpillar, Coca Cola, McDonalds and Walmart.
Fortunately for us, there are also some great Dividend Aristocrat ETFs that we can invest in if ETFs are your preferred method, or potentially a good way to start your investing journey. A couple that I would recommend are NOBL and SDY. Both have increased at least 32% in the last 5 years and have fairly strong Dividend Yields (over 2%). SDY has realized a 32% return in stock price over the last 5 years, but including the dividend, the total return is just over 46%.
In summary, there really is no true number that is going to tell you if a dividend yield is good. You don’t want to solely focus on yield because you could still lose out as we explored with PSXP. You also could target a company that has higher growth but a lower dividend such as Visa (one of my personal favorites), who only has a forward dividend of .62% but they’ve grown by 322% in the last 5 years, as well as 10 consecutive years of growing dividends. Dividends are a necessity to me, but they are not used as a tool to make the final decision.
To me, the dividend is nothing more than the cherry on top – but would you ever order ice cream without a cherry? I wouldn’t.