I think one of the most common misconceptions that investors have is regarding the value of investing in dividend-paying stocks. I hear this quite a bit from people who call me or email me and try to tell me the virtues of putting money into what they call “high quality, dividend-yielding securities.” And they can sound enticing – sometimes 7, 8, 9 percent dividend yields or more. But just because a stock is paying a high dividend doesn’t mean it’s a great investment for you.
Some people believe that dividend-paying stocks do better during market downturns. But do they really? In 2008, one HUGE American stock was paying a quarterly dividend of $0.31 per share. But In 2009, as the market had come crashing down, that same company cut its dividend to $0.10. And they weren’t the only one. According to Money Magazine and US News, 57% of dividend-paying companies, located in 23 developed markets, either reduced their dividends or eliminated them altogether.
Going after companies and basing your investment decisions solely on their dividend is what’s known as “chasing yield.” These investors jump toward high-dividend stocks like a game of “Whack-a-Mole,” only to get burned when that dividend yield gets cut or eliminated. Remember, there’s no such thing as a free lunch. An investment will not pay 7% in a 2% world unless some element of risk is involved.
In fact, new data from BNY’s Mellon Capital shows that over the past 20 years, companies that offered at least a 10% dividend yield actually paid out only around 3% over the next 12 months. (Source: CNBC)
Maybe you should look at the fundamentals of a company. It’s the VALUE factor – in other words, stocks that have low prices compared with earnings or other metrics, such as book value. Instead of being drawn in by the lure of a high-dividend yield, look at those companies that are GROWING their dividend at a healthy rate. Some of these companies may only yield 3 or 4 percent, but if that dividend is growing by, say 10 percent a year due to fundamentals, you might be looking at a much better stock.
There’s no shortage of financial press headlines telling you where to find high-yielding investment opportunities. But take a step back, and know that yield-chasing rarely ends well. Whether it’s stocks or bonds, once the inflection point happens, it’s just a matter of who’s left holding the bag.