We’re going to take a look at using relative yields when considering dividend stocks. This perspective will help ground our minds in what a reasonable range of sector dividend yields are for each sector, rather than looking only at the entire index.
We all know that some industries tend to pay high dividends while others pay low dividends, this analysis of the data will help to further that knowledge and give us a better feel for exactly what the divided yield numbers are.
Consider the chart below, which shows forward dividend yields for all 691 dividend paying stocks in the Russell 1000 broken out into the 11 major industry groups. If you aren’t familiar with it, the Russell 1000 is an index consisting of the 1000 largest U.S. stocks, the smallest market cap is just south of $1B.
The first thing that draws our attention are the sectors with above average dividend yields, particularly in telecommunications (6%), followed by real estate (4.5%) and utilities (3.4%). It isn’t a surprise that yield focused sectors pay high yields, nor is it surprising and sectors with below average dividends are primarily high growth industries and commodity stocks.
Clearly the sectors that you invest in will make a big difference on your overall portfolio yield, which is an opportunity but is also a problem. On one hand, we can pick and choose the best dividend stocks from each industry and end up with a portfolio that should yield at least 2.3%, and hopefully with less risk than the overall index.
On the other hand, the concentration of high yields in particular sectors tends to force yield seeking investors into concentrated portfolios, a risky endeavor.
Dividend investors tend to look for high yielding stocks and often use an index as a way to determine what is actually high and what is low. We think a better way than using the index overall is using the sector to determine a relative yield. For example an Industrial stock paying 2% is a high yield, while a real estate stock paying 2% would be considered a low yield.
It’s also worth taking a look at payout ratios by sector. This sample from the Russell 1000 uses the same stocks as the chart above, but in cases where the payout ratio becomes extreme, we have capped it to 150% so as not to throw the averages off too much.
It shouldn’t be too surprising to see the payout ratios correlate closely with the dividend yields, paying out a higher yield will typically absorb a greater amount of your earnings, increasing the payout ratio.