In Search of Dividend Yield: How Much is Enough?

dividend yield target
What dividend yield to target?
It depends.

I’ve written a few posts about dividend yield recently, such as how to calculate yield, and reasons for yield to be high, but I haven’t touched on the actual numbers you should be looking for until now.

A nice, simple straightforward answer would be great, wouldn’t it? Yeah, well, that’s not what you’re going to get.  The best answer I can give is: it depends. The good news is that I will tell you which two factors you should look at. Please keep in mind the fact that a stock’s yield alone is never enough information to base a buying decision on; it is a starting point, not an end point. Personally, I use dividend yield as one of my first filters so narrow down my buying options, but it is far from the last factor I consider.

Peer groups average yield

When considering what yield is good enough, you need to consider the stock’s peer group. To take a ready example, let’s look at Canadian bank stocks. This is a nice example to choose because while certainly not identical, these banks all do basically the same thing in the same market. Also, there is a limited number of companies to consider, making our task easier.

 Current Yield on Canadian Bank Stocks

Bank NameCurrent Yield (15 July 2013)
TD3.8
RBC4.0
BNS4.2
National Bank4.5
BMO4.7
CIBC5.0

Looking at the numbers, we can see that there is a relatively small difference from the highest to the lowest yield. This is good. Outliers are seldom a good thing when it comes to yield. If one of these were significantly different than the others, we would need to try to find out why. Of course, if companies operate in different parts of the market, yields may be different simply because of the nature of the business themselves. Remember that the market rewards risk with reward. In other words, the higher the return, the higher the market perceives the possibility of something going wrong. It is importantto remember, though that buy-low, sell-high investors often have a different view of what risk is. For them, risk involves future stock price movements. For dividend investors, risk involves the ability of the company to maintain or (ideally) to raise its dividend in the future. (Watching a stock you have just bought sink in price isn’t fun for anyone, but it’s not really the tragedy for dividend investors that it is for buy-and-sell-ers.)

Prevailing interest rates

After comparing similar companies, the next step is to compare to prevailing interest rates. These days, with interest rates at all-time lows, a 4 to 5% yield on something as relatively safe as a Canadian bank isn’t a bad deal at all. Back in the eighties, a yield of 4-5% would have been laughable; the world bank shows that interest rates in Canada were between 7 and 9%. (I have to confess I wasn’t paying a lot of attention to this kind of thing at the time, so it’s nice be able to look this up online. I love the Internet!) At some point in the future, if/when interest rates go back up, 4 to 5% will again seem a paltry return, but at present, for the same level of security, it’s hard to beat.

Whether comparing a stock’s yield to its peer group, or to prevailing interest rates, remember that if a yield is significantly higher than everything else around it, there is probably a reason, and until you at least know what that reason is, you’re best to stay away from higher-than-normal yields.

 

 

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