High yield dividend stocks: good or bad?

Blog post #411

With interest rates so low, clients and others have asked us about buying high yielding dividend stocks.

Their logic goes….wouldn’t it be a good idea to buy a stock that has a dividend yield of 4-5%, since this pays more than the interest rate on a CD? They could earn more income by owning the stock and receiving the dividend payments.

This sounds like a good idea, but, it does not always work out so well. The primary risk in this strategy is that the price of the stock could drop, which negates some or all of the higher dividend yield benefit. The other risk is that the company may not be able to continue paying the dividend at the same rate in the future…that the company would be forced to cut their dividend.

Currently, the companies in the S&P 500 Index, the largest companies based in the US, pay a dividend yield of around 1.85%. For example, if a company pays a dividend of $2.00 per share and has a stock price of $100, its dividend yield would be 2%. This would be pretty typical of a large US company in today’s market. If a stock is paying dividend yield that is far higher than 2%, say 4% or more, we would consider that to be a high yielding dividend stock.

Some examples of currently high yielding dividend stocks are: IBM, 4.47%; ATT, 5.27%; ExxonMobil, 4.83%; Verizon, 4.12%; Ford, 6.37%; Wells Fargo, 4.22%; Macy’s 8.83%.**

Examples of other companies with lower dividend yields would be: Apple, 1.42%; Wal-Mart, 1.83%; Microsoft 1.34%; and Costco, .88%.**

We are focused on your total return when we manage your money. This means we are focused on what happens to your principal (the amount of money you have invested and what happens to that balance over time), as well as the income (interest and dividends) which are generated from that money.

If you are focused primarily on the dividend or interest yield, you are not focusing on the total return.

Stocks that have a very high dividend yield have a high yield for reasons which are usually not good. You should view high dividend yielding stocks with the following guideline: risk equals reward. If a stock has a very high dividend yield, it usually means there is extra risk involved. The higher the dividend yield, the more cautious you should be about the stock. Remember this!

ABC stock may have had a 2% yield and a $100 share price. But if the stock price drops significantly, say to $50 per share, and still pays $2 per share a year in dividends, ABC Company now has a 4% dividend yield ($2 dividend/$50 per share stock price). This stock just became a high paying dividend stock.

This scenario is the usual case, as other than utility companies and REITs (real estate investment trusts), most companies don’t strive to pay 4-6%, or more, as a dividend yield. They get into that position usually because their stock price has dropped. The company has run into problems. Strong competition. Falling earnings and revenue. Debt problems. And their future earning forecasts would typically be going down.

For companies like this, which pay a far higher dividend yield than the norm, you should also consider the potential that the dividend may not be sustainable in the future. One prime example of this is GE, which due to serious financial problems had to drastically cut their dividend from 96 cents per year in 2017 (which was a 4% dividend yield at the time in September, 2017) to 4 cents per share per year in late 2018. GE stock went from $50 per share on January 1, 2000 to range over the last six months of around $9-11 per share. GE’s dividend yield is now approximately .44%. This is a very low dividend yield, but it is not a positive sign, as the company cannot afford to pay out more in dividends, due to the major business issues it faces.

While high yielding dividend stocks can pay good income, their stock performance may not be as good over the longer term, especially when compared to other indices or benchmarks. This is why we emphasize focusing on total return (the growth of your overall invested money), and not only on the dividend yield.

To provide an illustration, we researched many large companies with currently high dividend yields and compared their stock performance over the past 10 years. As the chart below shows, the performance of these high dividend yielding stocks were dramatically less than the performance of a globally diversified stock portfolio, such as we recommend.

The chart below shows how 3 of these stocks, IBM, ExxonMobil and ATT, performed over the last 10 years (from September 14, 2009 – September 11,2019), as compared to a globally diversified asset class mutual fund, DFA Global Equity Portfolio,*** which is invested in 70% US stocks, 30% International and Emerging Market stocks, with exposure to small companies and real estate stocks, with significant exposure to value stocks.

We clearly recognize that this is an illustration of only three companies, so it is not intended to be considered as definitive financial research. There may be high yielding dividend stocks which outperformed various benchmarks over the past 10 years. The point we are making is that by owning a globally diversified portfolio of asset class funds, we strive to provide you with better overall returns, than by just focusing on stocks with greater dividend yields.

As we reviewed a number of companies in researching this blog post, we noted the same pattern over and over. Companies that have high dividend yields now, had poor stock performance over the past 5-10 years. We do not know how these stocks will perform in the future, but we would not recommend that you build a portfolio of a few of these stocks as the core, significant portion of your investment portfolio.

All stocks come with risk. Stocks with much higher than average dividend yields come with much greater risk to your principal, your investment capital. We don’t think that is a risk that is worthwhile for the core part of your investment portfolio.

We hope that this is helpful and informative to you and your family. Sometimes our role is to provide you with guidance, and other times it is to help prevent you from making financial mistakes.

If you are considering purchasing high yielding dividend stocks, maybe you should talk to us first.

 

** Dividend yields as of September 11,2019, per Yahoo Finance.

***DFA Global Equity is presented to be representative of WWM’s globally diversified investment portfolio. It is not a representation of any client’s specific portfolio and is presented only for illustrative purposes. The chart does not reflect WWM’s annual investment advisory fee, but that would not materially change the outcome which the chart shows. For more information on DFA Global Equity, please see Dimensional Investments, ticker symbol DGEIX.

 

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