High And Low Dividend Yields And What They Tell Us About A Stock

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Dividend Yield – The dividend yield of a stock is the total dividend per share paid by a company divided by the market price of the stock. In other words, it can also be said as total dividend paid out by the company divided by its market capitalization.

There can be many conclusions that can be drawn from the dividend yield of stock, which would vary as per the set of circumstances revolving around the company. We will discuss about various circumstances when a high or low yield dividend would say something positive or negative about a stock.

HIGH DIVIDEND YIELD

Stage of Company – Generally a large company which is in a moderate growth industry would give a large dividend. Such companies have had a successful long run, their business have expanded widely, operations have streamlined, and they do not have any significant growth opportunities to explore. These companies have surplus cash at their disposal which they would distribute to their shareholders as dividends.

Given the moderate growth stage that these companies belong to, the prices of the stock are not very high compared to a high-growth stage company and also it is generally observed that such companies have a long and stable history of paying dividends. In such circumstance a high cash payout will certainly push up the dividend yield higher.

The returns generated by the shareholders in such companies is generally a mix of dividend plus capital appreciation.

A corporate action event – There can also be other circumstances when a company may be prompted to pay out a higher dividend. It may so happen that a company may have entered into a deal where it is selling off a part of its business at a significant profit. In such circumstances it will become cash rich in the short run with no immediate redeployment opportunities. In such a scenario, the company would either pay a high cash dividend to its shareholders or prefer to buy back its shares from them.

Such circumstances are usually rare but do happen and account for a windfall for the shareholders.

Poor performance – A company can pay more dividend than the profits it has earned in a year, or it may also happen that it may have run into losses, yet it would still be willing to pay dividend to its shareholders. The reason for this could be that the company may not want to lose its good standing with its shareholders or is trying to arrest a steep downslide of its stock price at exchanges following a disappointing financial performance.

Whatever the case may be, if the company is paying a dividend under such circumstances with a high dividend yield, the motivation is to distract the investor or market participants from its poor financial performance and divert attention towards current earnings so that a catastrophic share price performance may be avoided.

Liquidation Dividend- Although a rare event, but a company would pay a good dividend to its shareholders if it is going into liquidation. Such a situation does not arise if the company is going bankrupt, but in case of business decides to go into voluntary liquidation, it will first satisfy all outstanding claims against it and if after that there are any remaining assets at its disposal whose combined value is more than the face value of its shares it will pay a liquidation dividend to its shareholders.

This event is however in the nature of returning of capital to the shareholders in excess of the amounts they had invested in the company, instead of paying a portion of the earnings of the company.

Other reasons for High Dividend Yield – The stock market volatility could be another reason for a high dividend yield for the shareholders of a company. Temporary factors like  an adverse macroeconomic event or an adverse political event or an event specific to the company that has got no relation to the business performance of the company, like say the sudden death of its CEO or arrest of one of its directors on matters not relating to its functioning, may pull down the share value of the company in the stock market. When an Investor buys the shares of the company under such circumstances, his dividend yield would be higher because the price of the share has plummeted.

Investors building a portfolio of dividend stocks and fund managers usually try to buy good dividend paying stocks when their prices are depressed so that the total return of their portfolios are high.

High dividend yield vs Health of a company – In the light of the above discussion it can be said that a high dividend yield is no surety of good health of a company nor is it a guarantee that the company will continue to pay a high dividend. What the investor should concentrate upon is the company’s history of dividends. If the company is consistent in its past, it is a sign of long-term health of the company and also that it is more likely to pay a good rate of dividend compared to a company with a non-consistent track record.

 

LOW DIVIDEND YIELD

Just as high dividend yield is no guarantee of the good health of a company in the same way a low dividend yield or no dividend at all is not a sign of bad health or poor business performance of the company.

Stage of Company – Generally a company which is an early growth stage company will not pay any dividend or pay very less dividend. Such companies usually face a very high growth trajectory and would want to fund their growth instead of parting ways with the profits earned. These companies will rapidly employ more people, acquire more assets and equipment even by borrowing money to take advantage of the high growth market environment.

Cash for these companies is the most valuable resource and they would the scouting for every opportunity to raise more and more cash. Such companies offer high risk, high return prospects to its investors, with the returns generated by shareholders on their investments coming entirely from capital gains.

Transaction failure or regulatory penalty – There can be circumstance during the course of business dealings of a company that it may have to part with a significant part of its cash holdings towards a failed business transaction or a regulatory penalty, which has a onetime material impact on its  profitability for a particular period. Under such circumstances the company might not declare any dividend or pay a very low dividend in order to recover from such an adverse event.

A lower dividend yield in such a situation is no reflection of the long-term business performance of the company.

Accident or calamity – It may also happen that there has been an accident at any of the company’s sites or it has been hit by some natural calamity due to which it has had to suffer temporary losses. Under such circumstances as well the company might not declare any dividend or pay a very low dividend in order to recover from this accident or calamity.

A lower dividend yield in such a situation is no reflection of the long-term business performance of the company.

Poor business performance – The company during a particular period might have performed poorly. The reason could be many, like a poor macro-economic environment, adverse taxation, raw material supply constraints or other such reasons. Under such circumstances the company may not have enough surplus to pay dividends to its shareholders.

A lower dividend yield in such a case is a reflection of the financial performance of the company.

Merger and acquisition – When a company decides to go in for a merger or acquisition activity it involves major financial dealings. In such cases the company will try to conserve as much cash as possible so as to fund not only the deal but also the associated integration. High cash amounts must also be maintained by the company to take care of any unforeseen circumstances post integration, which could have a bearing on the health of the combined entity. A lower dividend payout during such a period is evident and it does not reflect poorly on the health of the company. Such events are high value creation opportunities for shareholders. Companies may also want to conserve cash in anticipation of such events.

Poor Business OutlookMost of the times companies try to conserve cash, in the event of an impending adverse economic or business environment during which the company expects a contracted business activity. The company, during such situations as well, has to bear certain committed costs like salaries, rents and electricity bills among other things to maintain itself as a going concern.

In the above event as well, the company will pay a lower dividend in order to conserve cash. This action accentuates the prudent behavior of the management to work in the best interests of the company and its shareholders.