What Determines A Dividend Stock's Yield

If income investing were as simple as picking the stock with the highest yield, everyone would be an expert. Most assume (rightfully so) that yield is heavily influenced by risk, but much more goes into determining yield. Below are several important factors that influence a stock's yield, along with some illustrative examples:

Industry
Have you ever noticed that stocks within an industry often have similar yields? This makes sense when you consider they often have like operations with similar processes, cost structures and margins. This is evident when you look at retailers who buy similar products, resell them in a physical location and have fairly low margins due to the intense competition. Note the yield similarity of The Coca-Cola Company (KO) with a 3.2% yield and Pepsico, Inc. (PEP) with a 2.9% yield.

Maturity and Growth Potential

When Microsoft (MSFT) and Apple Inc. (AAPL) were formed they paid no dividend. Instead they funneled all their cash back into growing the business. As they matured and growth slowed, each began to pay a very nominal dividend. Today, as they have continued to mature, their yields have continued to increase with MSFT paying 0.7% and AAPL paying 0.6%.

Legal Considerations

Real Estate Investment Trusts (REIT), such as Realty Income Corp. (O) and National Retail Properties, Inc. (NNN), are not taxed as standalone entities. Instead, they are legally required each year to pay out a high percentage of their profits as dividends. In effect this forces the shareholders to incur the tax as earnings are generated. This leaves the company very little cash to fund future growth. To pay for growth, REIT's usually have to issue debt and/or equity. All of this combined usually results in REITs having a higher than average yield, for example O yields 5.7% and NNN yields 5.3%.

Risk

Risk still plays an important role in setting the yield for a company. Consider these energy companies with a similar yields: Chevron Corp. (CVX) with a 4.2% yield and Exxon Mobil Corp. (XOM) with a 3.3% yield. Then there is BP plc (BP) with a 4.6% yield. BP has historically been the more risky stock to own?

The above list is not meant to be an exhaustive, but highlights some of the more common drivers of yield. When we see a yield that appears to be too good to true, we need to ask ourselves why is the yield so high, and is it sustainable?

Full Disclosure: Long KO, PEP, MSFT, AAPL, O, NNN, CVX, 

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Tags: KO, PEP, MSFT, AAPL, O, NNN, CVX, XOM, BP,