Is a 6% dividend yield twice as good as a 3% dividend yield?

If someone was to ask whether £6 is twice as much as £3, the answer would be clear. When it comes to judging a dividend yield, though, things can be a bit more complicated.

For example, is a 6% yield twice as good as a 3% one?

In some ways, it can be. If someone buys a share at a 6% yield and the dividend is maintained, it ought to generate twice as much in passive income as if they invested the same amount in a 3%-yielding share that maintained its payout.

In other ways, though, that is not necessarily the full picture.

Dividends are never guaranteed to last

For starters, there is the fact that a company can choose to cut or cancel its dividend at any point.

A 6% yield is a historic snapshot.

Yes, sometimes the yield is prospective, not backwards-facing – but in such cases, there is no guarantee that the estimated payout will in fact materialise.

Sometimes, a high dividend yield can be a red flag about dividend sustainability. So I sometimes have more question marks about a 6% dividend yield than one half that size. In reality though, any company that pays a dividend can reduce it. Plenty of companies yielding 3% or even far less have slashed their payouts over the years.

So, whatever the yield, my focus would be on how sustainable I thought a dividend looked.

To assess that, I would look at what I thought a company’s financial performance is likely to be in future, including cash flows and the balance sheet.

Thinking about long-term value

I also think it is worth paying attention to how a company Is funding dividends.

For example, some large businesses in mature, highly cash generative sectors, may simply be paying dividends because they see no other appealing use for the money.

But in some cases paying a dividend can mean adding debt to the balance sheet, or foregoing investment that could lead to growth. In such situations, the financial appeal of a high yield now can obscure the risk that the long-term business value may fall.

That can mean a lower share price and matters because a high yield may be attention-grabbing, but total return on a shareholding consists of share price gains (or falls), as well as any dividends received.

Here’s a 6%+ yield I like!

That is one risk I see with FTSE 100 asset manager M&G (LSE: MNG).

Supporting the company’s 6.7% dividend yield means that cash the company could otherwise spend on customer acquisition is paid out to shareholders.

Given M&G’s inconsistent performance in recent years when it comes to getting more money put into its funds by clients than is taken out of them, that matters.

Then again, a strong brand and large customer base spread across multiple markets are strengths as I see it.

M&G has proven its ability to generate sizeable cash flows. That helps support a strong dividend – and the firm aims to keep growing its payout per share annually.

For income-focused investors, I see it as a share worth considering.

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Christopher Ruane does not hold any positions in the companies mentioned.