“There is no exception to the rule that every rule has an exception”
–James Thurber, author, humorist, cartoonist
I don’t like rules… especially when they seem arbitrary.
It’s even worse when it comes to investing rules that try to put everything in a nice little neat box. If it were that easy, well, everyone would be rich.
I’ve been in the finance industry for over a decade and have learned to ignore rules like these.
Sure, I have a set of guidelines when selecting contenders for our investment dollars. But I’ve found setting hard-and-fast rules can sometimes lead me in the wrong direction.
Instead of trying to put each number in preset requirements, I use a lot of ratios. A ratio is simply a relationship between two numbers.
I find watching patterns in the ratios tells me a lot about a company.
One important ratio for income seekers is dividend yield.
A company’s dividend yield is simply the annual dividend amount as a proportion of the share price expressed as a percentage. Here’s the math:
Yield = Annual Dividend Payments/Share Price x 100
It tells you how much you’re getting paid for the money you’ve invested.
The higher the dividend yield, the harder your money is working for you.
The same applies to the interest rate on a bank account. The bank pays you interest as an incentive for you to park your money with it.
Dividends are the most obvious way that companies can return value to shareholders. It’s one way to incentivize you to buy shares and claim an ownership stake in that company.
And the more dividends we collect, the faster we can grow our money.
Is There an Ideal Dividend Yield?
I love this question. It seems simple, but it’s not.
There’s plenty of advice out there that uses seemingly arbitrary numbers to answer that question. Between 2%–4% is a common answer.
Rejecting the “rule” that says high dividend yields are dangerous can boost your income substantially.
It’s become cliché advice that high dividend yields are not sustainable over time. Or to say that high dividends are just a ploy to lure in desperate income investors.
While that can sometimes be the case, following a rule like this can cause you to miss out on great high-income-generating opportunities.
And I can prove it.
Take Altria Group, Inc. (MO) for example.
This tobacco giant is the company behind leading brands such as Marlboro, Black & Mild, and Skoal. Altria also has ownership stakes in beer brewer Anheuser-Busch (BUD), electronic cigarette maker JUUL Labs, and cannabis research company Cronos Group (CRON).
Tobacco, cannabis, and alcohol are all industries that thrive in any economic climate or market condition. Even as inflation roars higher, consumers will dial back spending elsewhere before they cut these vices out of their budgets.
Not All High-Yield Stocks are High Risk
Dividend investors love Altria. It has not only paid a dividend for over 50 years, but it has raised its dividend 57 times in the last 53 years.
And right now, this Dividend King has a dividend yield of 8.2%.
If you’re guided by a hard-and-fast rule that says all yields over 5% are dangerous, you’d miss out on this high-income opportunity. Altria hasn’t had a yield in that “safe zone” since 2018!
And in 2020, Altria’s annualized yield peaked at 10.7%. Yes, some investors are collecting a double-digit yield on this solid consumer staple.
That’s the problem with one-size-fits-all rules. Following them can be costly. Altria’s dividend has been stable and increasing over the past few volatile years.
You would have cheated yourself out of thousands in additional dividend income by using 5% as a hard-and-fast rule.
Altria has survived an array of economic and political challenges over the past 53 years. And through it all, it’s continued to profit and return solid value to shareholders. It’s an 8%+ yield that shouldn’t be feared.
This of course is not the case with every high-yield dividend stock.
And in volatile markets, like we have today, we could see more opportunities to lock in these inflation-beating yields.
When the Market Slides, Yields Go Up
As I noted above, yield is a ratio. And it fluctuates for two reasons:
Companies change their dividends
Share prices rise or fall
It’s simple math. Share price and yield are inversely related. If the dividend amount stays stable, as the share price falls, the yield goes up. And when the share price rises, the yield goes down.
You can see this relationship between price and yield in Altria’s case. In 2017, the stock hit an all-time high, pushing its yield down below 4%.
Right now, the entire market is seeing a similar situation.
The S&P 500 is down 22% off its 52-week high. And there are individual stocks that are down even more.
As share prices go down, dividend yields go up.
A lot of share price movement we’ve seen over the past three years was driven by investor sentiment, and not due to changes in company fundamentals. That’s where you’ll find the real high-yield opportunities.
Please remember, it’s always important to look at everything on a case-by-case basis. Dividend yield is not the only factor to consider when choosing a stock for generating income. We’ll continue to look at other considerations in these pages week after week.
Rules are a great way to protect ourselves from making poor decisions. But, if you set a hard-and-fast rule based on an arbitrary magic number, you’re sure to miss out on great opportunities.
For more income, now and in the future,