High Dividend Yields: What's the Catch?
High-yield dividend stocks often look attractive — especially to income-focused UK investors — but unusually high yields can signal potential problems. A soaring yield is frequently caused not by rising dividends, but by a falling share price, which often accompanies weakening business performance.
This page explains why high yields can be dangerous, how to spot red flags, and how to assess whether a dividend is sustainable.
Why Do Some Dividend Yields Look Very High?
A dividend yield is calculated as:
Dividend Yield = Annual Dividend per Share ÷ Share Price
Therefore, a yield can become artificially high when the share price collapses. For example:
- Dividend: 30p per share
- Share price falls from £6 to £3
- Yield jumps from 5% to 10%
This rising yield is a warning sign, not a gift.
Common Red Flags of High-Yield Stocks
1. A Falling Share Price
A collapsing share price usually reflects:
- profit warnings
- declining revenues or cash flow
- increased debt levels
- sector downturns
If fundamentals are deteriorating, the dividend may become unsustainable.
2. Unsustainable Payout Ratios
The payout ratio shows how much of a company's earnings are paid out as dividends:
Payout Ratio = Dividends ÷ Earnings
As a rule of thumb:
- Under 50%: Generally healthy
- 50–80%: Acceptable for stable companies
- Over 80%: Risky
- Over 100%: Dividend is being funded by debt or cash reserves, not profits
Companies frequently cut their dividends when payout ratios become too high.
3. Falling Cash Flow
Dividends are ultimately paid from cash, not accounting profits. A company with shrinking free cash flow may struggle to maintain payouts even if profits look stable on paper.
4. High Debt Levels
High-yield companies often operate in capital-intensive sectors such as real estate, telecoms, or utilities. If debt servicing costs rise (e.g., after interest rate increases), dividends may be cut to preserve liquidity.
5. Sector-Specific Risks
Some industries regularly produce high yields but carry elevated risks:
- REITs – sensitive to interest rates and property valuations
- Telecoms – high debt, slow growth
- Oil & Gas – cyclical and commodity-dependent
- Asset Managers – earnings tied to market performance
High yields in these sectors may be normal, but still warrant careful analysis.
Interactive: "Is This Yield Too Good to Be True?" Checker
Enter a company's dividend yield and payout ratio to get an instant assessment of potential risk.
How to Assess Whether a Dividend Is Sustainable
Before investing in a high-yield stock, UK investors should review:
- Five-year dividend history – are dividends stable or declining?
- Earnings trends – is profit growth consistent?
- Free cash flow – does the company generate real cash?
- Debt levels and interest costs
- Management commentary in annual reports and trading updates
- Sector conditions – is the industry stable or shrinking?
High yields can be sustainable in some sectors, but only if backed by strong fundamentals.
Summary
High dividend yields can be tempting, but they often signal trouble. A collapsing share price, unsustainable payout ratios, falling cash flow, or high debt may indicate that a dividend cut is imminent.
Investors should always investigate the reasons for a high yield rather than assuming it represents a bargain. Sustainable income comes from strong, stable companies, not from the highest yields on the market.