What's the Sweet Spot for Dividend Yields?

Includes: CLX, HAL, HOG, MCD, MRK, UL
by: Sigma Swan

Dividend yields have a bit of a "Goldilocks' porridge" quality about them. Investors have to get a taste for different yields while searching for the ones that are just right. Pick one that's too low, and you'll be risking your money and not getting paid enough for taking on that risk. But pick one that's too high and you could get seriously burned.

Just Right

That sweet spot of dividend yields, I believe, sits at between 3-5% these days, or just above 10 year Treasury rates. There are plenty of large cap companies paying dividends in this range which have been raising their dividends over the last five years. Running a screen for these metrics yielded about 40 stocks for me. Here are a few choice picks from the bunch:

Unilever (NYSE: UL)

Market Cap: 84 Billion

Yield: 4.75

Dividend Growth Rate (5 year average): 17%

McDonald's (NYSE: MCD)

Market Cap: 80 Billion

Yield: 3.21

Dividend Growth Rate (5 year average): 29%

Clorox (NYSE: CLX)

Market Cap: 9 Billion

Yield: 3.23%

Dividend Growth Rate (5 year average): 14%

It would be hard to go wrong with three mega caps that boast diversified brand portfolios and long histories of dividend growth. But if you can't contain your curiosity, you can try out a few other yields out for size.

Too Low

Consider the case of Halliburton (NYSE:HAL), an oil and gas company with a market cap of over 40 billion. Halliburton's current yield is 0.75%, which is less than what you can get from a 2 year U.S. Treasury bill. One of these investment options is backed by the full faith and credit of the U.S. government, and the other one is (probably) not.

To qualify as a good dividend yield, it has to compensate investors for the extra risk of owning stocks instead of bonds or bank CDs, so the yield shouldn't be too low.

Too Steady

Consistency is a prized value in dividend stocks. So much so that the S&P 500 has a special class of dividend payers called dividend aristocrats which have raised dividends for at least 25 consecutive years. But consistency can cut both ways.

Take a look at Merck (NYSE: MRK), a pharmaceutical company with a mega-market cap of over 100 billion. It currently sports a hefty yield of over 4.5% which is no small potatoes when 10 year Treasury bonds are paying around 3.75% and most bank savings accounts are yielding less than 1%. But as with so much of investing, the important aspect of the dividend yield is all about the future, not the present. And that's where Merck comes up short. The company has been paying the same exact dividend for over six years, without a single hike since September of 2004!

That's not the kind of consistency that dividend investors hope for. To qualify as a good dividend yield, it has to be growing.

Too High

In early 2008, Harley Davidson (NYSE: HOG) had a dividend yield of $0.33 per share, or over 6% when 10 year Treasury bonds were paying less than 4%. Not bad at all. But investors who were selling Harley stock for fear of the recession were right to keep the stock price down and the dividend was slashed by 70% in the next quarter.

To be a good dividend yield, it must be sustainable and shouldn't be temporarily inflated by a low stock price. In other words, it shouldn't be too high.


I'd love to hear your thoughts. What do you look for in a dividend yield? Found any great yields that don't meet these criteria?

Disclosure: I am long HOG, MCD.