Does a High Dividend Yield Always Mean a Good Investment?
Let’s talk about something that gets dividend investors super excited – dividend yield. You see a high number there, and it’s like, “Wow, this company is giving an 8% dividend yield! Time to cash in!” But hold up! Let’s take a step back and think: Does a high dividend yield really mean it’s a good investment? Is it too good to be true?
What Is Dividend Yield?
First off, for those new to investing, dividend yield is like the “interest” a company pays to its shareholders. Here’s the formula:
Dividend Yield = (Dividend per Share ÷ Stock Price) × 100%
So, if a stock costs RM10 and pays a RM1 dividend per share, the dividend yield is 10%. Sounds great, right? But wait – there are some things you need to check before jumping in.
High Dividend Yield: A Hidden Trap?
Sometimes, a high dividend yield is more of a red flag than a green light. Here’s why:
1. Falling Stock Prices
A high yield can happen because the company’s stock price has dropped. Imagine a stock that was RM20 but is now RM10. If the company still pays a RM1 dividend, the yield jumps from 5% to 10%. Sounds awesome, right? But ask yourself – why did the stock price drop? Is the company in trouble? Sometimes the trick is there, where the company is facing certain business challenges, still they pay high dividend to attract or maintain existing investors.
2. Unsustainable Dividends
Some companies try to keep their dividends high to attract investors, even when they’re struggling. This could mean they’re borrowing money or cutting other expenses to pay dividends. Not exactly sustainable, right? However, we will see sometimes certain company will pay dividends more than their earnings exceptionally once, but as long as the company is not doing so yearly, then that is still justifiable, provided the company’s financial performance is strong and stable over the years.
3. Business Health
A high dividend yield might mean the company isn’t reinvesting enough in growth. Sure, it’s nice to get paid now, but what about the company’s future? No growth = no long-term gains. As a smart investor, we have to accept a fact that company needs money to grow their business, therefore we cannot expect a growing company should pay high dividends to investors, instead should retain some earnings to focus on growing the business. Therefore, as a dividend investor, we should filter and choose the dividend stocks that suit to our requirements.
So, What Should You Do?
Here are some tips to make sure you’re not falling into the high-yield trap:
1. Check the Payout Ratio
This shows how much of the company’s earnings are going to dividends. Generally, if it’s more than 70-80%, it might be risky, but the case is different for Real Estate Investment Trust (REITs) because of certain policy imposed on REITs, REITs must distribute at least 90% of the income to the unitholder in order to waive the tax on income.
Source: Shareinvestor.com (Stock: Maybank)
2. Look at the Company’s Fundamentals
Is the company’s revenue and net profit growing? What’s the cash reserve level? How’s its debt ratio? How’s the company cash flow? A solid business is more important than just a high yield. It’s very important to gauge from the company past years financials’ point of view and at the same time assess whether the business the company in is growing.
Source: Shareinvestor.com (Stock: Maybank)
3. Compare with Industry Standards
A 10% yield might seem amazing and attractive to the investor, but if similar companies in the same industry are giving 3-4%, that’s a red flag. For instance, Maybank is giving out 9% yield constant yearly, but CIMB Bank, Public Bank, RHB Bank are only giving out 4 – 5% per annum, then it’s a red flag from Maybank.
Conclusion
A high dividend yield can be super attractive, but it’s not always a good sign. Sometimes it’s a warning that the company isn’t doing so well. Always do your homework and look beyond the numbers. Remember, investing isn’t just about the short-term gains – it’s about building long-term wealth.
What do you think? Have you ever been tempted by a high dividend yield? Share your experience below!
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