What is a good dividend yield for a stock? The answer depends on your investment strategy. Some investors prefer to buy stocks that have lots of growth potential while others may prefer to target value stocks.
In the case of growth stocks, many do not pay a dividend at all while others pay very little. On the other hand, established blue chip companies who are not growing as fast tend to pay a higher dividend. This is to attract investors in search of steady income.
I am an income investor, which is why I have focused on determining what a good dividend yield for value stocks is. While there are some exceptions, I try to stick to the following rules when looking at dividend yields.
Avoid the Highest Dividend Paying Stocks
Don’t make the same mistake I did when I started out building my income portfolio. You may be surprised to learn that some stocks offer yields well above 10%! That’s right – there are many stocks that have double digit dividend returns. Unfortunately, these yields are usually not sustainable and should be avoided at all costs.
I made the mistake several years ago of chasing the highest yielding stocks. I targeted income trusts that paid out over 15% in dividends. During the first couple of months the returns were fantastic. However, as the stocks of these companies began to correct themselves, I felt the pain of my mistakes. Avoid chasing these risky high yielding stocks – no matter how tempting they may be.
Look for Stocks with a Current Yield <= 7.0%
When I screen for dividend stocks now, I automatically rule out any company with a yield over 7%. Even companies that have a yield between 5% – 7% tend to raise a red flag for me. It is difficult for companies to sustain a dividend much over 5% for an extended period of time, so be cautious.
Stocks that Pay Low Dividends
A value stock that pays a low dividend is not much use to me. Since I am risking my money to own shares in a company, I want to receive a competitive return on my investment. In many cases, a certificate of deposit (CD) or treasury bond may offer a better yield than a stock. Since most CD’s are FDIC insured, my initial investment dollars are safe which is not the case with stocks.
At the time of this writing, Bank of America (BAC) stock was yielding 0.60%. On the other hand, Ally Bank was offering a 12 month CD at .99%, which is a much safer way to invest.
Even in a low interest rate environment, a CD can offer much higher yields than many stocks. Since my focus is centered around building a income portfolio of assets, I need to make sure I am getting a fair yield on my money. I want to be paid for taking on the added risk of owning stocks.
Look for Stocks with a Current Yield >= 2.5%
Most of the time, I filter out stocks with a current yield lower than 2.5%. Anything less and I prefer to invest my money into other assets.
The Perfect Yield
I prefer to pick stocks that are yielding between 2.5% and 5.0%, although I would consider stocks that yield up to 7.0%. There are always cases when a stock may drop in price, yet the dividend is still in good shape.
It is also important to note that not all stocks with a yield in this range are good investments. Investors must combine the current yield with other criteria like payout ratios, the P/E ratio, dividend growth rates, yield on cost, and more to make educated investment decisions.
Current Yield Between 2.5% and 5.0%
I prefer to screen for dividend income stocks that offer current yields between 2.5% and 5.0%. Most other stocks are either too risky (high yields) or don’t provide a high enough return (low yields) on my investment dollars.
What is your preferred dividend yield for owning a stock?