Dividend yield is a widely used metric that shows how much a company pays in dividends each year relative to its share price. Expressed as a percentage, it’s calculated by dividing the annual dividend per share by the current share price and multiplying by 100. For example, if a company pays R5 annually and its stock trades at R100, the dividend yield is 5%.
This makes it easier for investors to compare income potential across different stocks. However, not all dividend payouts reflect a company’s long-term ability to generate income, especially when special, one-off dividends come into play.
Special Dividends and Yield Calculation
A special dividend is a non-recurring payout issued by a company, often triggered by unusually strong profits, excess cash, or the sale of an asset. While it could boost short-term income, it’s not included in dividend yield calculations because it’s not expected to happen regularly. Including special dividends would distort the actual income potential of a stock and mislead investors about the company’s typical payout behaviour; recurring dividends often provide a clearer picture of consistency and sustainability.
What’s Considered a Good Dividend Yield?
A good dividend yield depends on a company’s financial health and an investor’s personal goals. According to The Motley Fool:
- Yields between 2% and 3.5% are typically seen as stable, especially from companies with balanced growth and income.
- Yields from 3.5% to 6% may offer higher returns but often carry more risk.
- Yields above 6% could be red flags, signalling possible earnings issues or dividend cuts.
High yields could potentially be worthwhile if the company has the fundamentals to support the payouts over the long term.
Why a High Yield Isn’t Always a Good Sign
While high dividend yields can catch an investor’s eye, they’re often the result of a falling share price. When a stock drops suddenly, usually due to concerns around revenue, earnings, or cash flow, the yield can spike, even if the company is struggling.
This was evident during the early stages of the 2020 pandemic, when many travel companies showed yields over 20% following sharp price declines. Despite the appealing numbers, most of these companies suspended their dividends shortly after. It’s a reminder that yield alone doesn’t tell the full story.
Conclusion
When assessing dividend yield, it’s essential to go beyond the headline number and consider where the dividend is coming from. Do consistent earnings and healthy cash flow fund it, or is it propped up by short-term gains or declining share prices?
Understanding the source of the payout and why the yield sits at its current level can reveal a lot about its sustainability. Ultimately, investors should ask whether the company’s fundamentals, such as revenue stability, debt levels, and long-term strategy, can realistically support ongoing dividends.
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