Whether or not you consider yourself an income investor, higher yields have a natural pull.
After all, a 10% yield is much more attractive than a 2% one.
However, unusually high yields may sometimes signal a warning rather than a bargain.
Why Dividend Yield Can Suddenly “Explode”
Dividend yield is calculated by dividing the annual dividend by the company’s share price.
Hence, a yield can suddenly “explode” because dividends have risen or share prices have fallen sharply.
A collapsing share price that triggers higher yields, however, is a cause for concern.
Here are four red flags that all investors should watch out for in massive dividend payouts:
Red Flag #1: The Dividend Isn’t Covered by Earnings
When a dividend payout ratio exceeds 100%, the company is paying out more than it earns and could be relying on cash reserves or debt to maintain dividends.
The sweet spot is typically between 50% and 75%, which rewards shareholders while retaining enough for reinvestments.
For example, DBS Group Holdings Ltd (SGX: D05), Singapore’s largest bank, has a payout ratio of 65.5%, while the national carrier, Singapore Airlines Limited (SGX: C6L), has a 70.4% ratio.
Investors should also be wary of one-off profits like tax benefits, which can inflate earnings and make the payout ratio appear healthier.
Red Flag #2: Weak Free Cash Flow
Earnings alone also do not tell the whole story.
Dividends are funded with cash, making operating cash flow (OCF) and free cash flow (FCF) critical indicators of dividend sustainability.
OCF measures the cash generated from the company’s business activities, while FCF represents the cash remaining after deducting capital expenditure (capex) needed to maintain or expand the business.
A business with weak or negative FCF is a warning sign, as the company may have to draw on cash reserves, sell assets, or borrow more to pay dividends.
For Real Estate Investment Trusts (REITs), focus on metrics like distributable income or cash available for distribution, which take into account the cash that could actually be distributed to unitholders.
Red Flag #3: Rising Debt to Maintain the Dividend
An organisation taking on debt just to sustain or raise its dividends is something to avoid, especially when earning capacity and cash flows stagnate or decline.
Additional debt increases refinancing risks and incurs more interest payments, leaving less cash for future dividends or business investments.
Supermarket chain Sheng Siong Group Ltd (SGX: OV8) is a green flag in this aspect as it is known for its strong balance sheet and consistent profitability.
For the first half of 2026 (1H2026), revenue grew 11.9% year-on-year (YoY) to S$855.4 million, and net profit attributable to shareholders increased 11.7% to S$80.8 million.
Sheng Siong also continues to remain debt-free, with S$402.3 million in cash as at 30 June 2026.
Red Flag #4: The Business Is Deteriorating
Sometimes the market is signalling genuine concerns.
Years of declining profits show weakening demand for a company or its products.
Changes in technology or consumer behaviour can also weaken a business.
Take Singapore Press Holdings (SPH) for instance.
Years of falling print advertising and circulation revenue steadily eroded its earnings, and its dividend fell along with them.
The media business was transferred to a not-for-profit entity in December 2021, and the company was privatised and delisted the following year.
However tempting the yield, a deteriorating business risks ensnaring you in a value trap.
Not Every High Yield Is a Trap
A high yield is not always a red flag – it can sometimes offer an attractive opportunity.
Rather than deterioration of the underlying business, it could be due to temporary market sell-offs or short-term economic uncertainty.
The key is to understand why the dividend yield is high.
Investors should analyse a company’s balance sheets, cash flows, and competitive advantages, as businesses that are strong in these aspects generally sustain payouts better even through difficult economic cycles.
Metrics such as net debt and debt maturity profile also help determine whether the company can comfortably meet its financial obligations while continuing to reward shareholders.
Finally, look into a company’s dividend track record and payout ratio.
Reliable income anchors like Oversea-Chinese Banking Corporation Limited (SGX: O39), or OCBC, and DBS have long-standing, multi-decade track records of consistent dividend payouts.
OCBC declared an interim dividend of S$0.47 per share, up 15% from S$0.41 a year ago.
Similarly, DBS declared an interim dividend of S$0.66 per share plus a capital return dividend of S$0.15, bringing the quarterly payout to S$0.81 per share, an 8% YoY increase.
A Simple Dividend Safety Checklist
Before investing in any dividend-paying company, it is useful to ask yourself:
- Are dividends covered by FCF?
- Does the company have a healthy balance sheet?
- Has management maintained or grown dividends over time?
- Is the business fundamentally healthy?
- Is the current yield unusually high compared to its historical average, and if so, why?
These questions will highlight dividend sustainability, helping you make an informed choice before investing in any company.
Common Mistakes Income Investors Make
Buying purely based on dividend yield is a common folly.
A high dividend yield might hide problems rather than true value.
Sufficient cash flow is needed to fund dividends, and overlooking FCF would be a costly mistake.
You could be buying a value trap if you ignore weakening business fundamentals.
Structural weakness would not only affect dividends but also the company’s overall profitability.
Assuming past dividends guarantee future payouts is also a frequent mistake.
A long history does not guarantee that future dividends will remain unchanged.
Last but not least, concentrating too much of your portfolio in high-yield stocks can be risky.
Diversify your investments across sectors and asset classes to reduce the impact of market volatility.
Get Smart: A Safe Dividend Is Better Than a Spectacular One
A high dividend yield may be tempting, but a sustainable payout that increases over time beats one that pays high now and ceases next year.
By looking beyond the headline yield, the smartest investors examine underlying fundamentals to identify genuine opportunities that can reward them steadily in the long run.
One of these six companies is the only one legally allowed to operate in Singapore. It has increased its dividend for 16 consecutive years. Discover which one it is in our free report here.
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Disclosure: Wenting A. does not own any of the stocks mentioned.
