What constitutes a good dividend yield is relative to the market conditions in a period in addition to the types of payments comparable companies are making. Generally speaking, a higher dividend yield is more attractive than a lower yield, because the yield reflects the types of returns that you earn. Nonetheless, a dividend yield may be driven higher by factors that disguise the fact that an investment is not a good choice.
A "good dividend yield" is a relative thing, based on comparisons with other stocks, bonds, and global interest rates.
What Are Dividends?
Dividends are quarterly cash payments that companies make to shareholders as an incentive to invest in the stock. To get the dividend yield, which is expressed as a percent, use the dividend yield formula: divide the average yearly payout by the stock's latest price, or market value.
A stock's dividend yield coupled with returns earned from a rising stock price comprise the investment's total return. A dividend yield can be driven higher by one of two factors: either the company is raising the size of its payout or the market value is falling.
Role of Company Profits
A good dividend yield is one that is rising because a company's profits are increasing and they are subsequently lifting the size of their payout. Of the 505 companies included in the S&P 500 index, 415 paid a dividend, as of the first quarter of 2018, and they increased their distributions by an average of 13.9 percent in that quarter alone, according to a 2018 U.S. News & World Report article. A good yield would be one that is inline with or higher than the average at that time.
The Dividend Payout Ratio
A good stock yield is one that will not come to an abrupt end. While you can't always know when a company will experience financial hardship and decide to suspend its dividend, you can look for some telling signs, such as the payout ratio.
A payout ratio is learned by dividing a stock's dividend by its earnings per share, both of which are disclosed on a quarterly basis. The higher the result, the more of the company's earnings it is depending on to reward investors with dividends. If a payout ratio is near or surpasses 100, the company may not be able to afford making payments in the future. The lower the result, the more likely the company can sustain its dividend commitments.
A high payout ratio is a danger sign because not only does a dividend cut reduce the amount of income you earn, but it also tends to drive the stock price of the underlying company down.
Comparison With Bonds
Dividend stocks are often compared with bonds because both investments provide investors with a stream of ongoing income. To determine whether or not a stock has a good dividend yield, compare the stock's yield to those being offered by government Treasury bonds. Even though income is a staple for bonds and optional for stocks, when bonds are offering especially low yields, dividend yields may look more attractive. According to MarketWatch, even in 2018, when the yield on the 10-year Treasury note broke above 3 percent for the first time since 2011, 43 stocks in the S&P 500 yielded more than 4 percent.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.