Not so many years ago, dividend stocks were often dismissed as staid and old-fashioned. Particularly in the 1980s and 1990s, many investors snubbed dividend stocks in favor of stocks that were rapidly appreciating in value.
It’s different today. At a time when fixed-income yields are near historical lows—just as a whole generation of baby boomers is at or near retirement age—dividend investing is very much back in favor. Even USA Today anointed the “stodgy dividend-paying stocks that Grandpa and Grandma used to buy” as the “new rock stars on Wall Street.” But whenever a strategy becomes the darling of financial advice columnists and bloggers, it may be time to proceed with extra caution. As straightforward as dividend investing may appear, investors commonly make mistakes that undercut both the income potential and the total return of their portfolios. Forward’s Dividend Signal Strategy team has compiled this list of seven pitfalls investors should avoid.
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Chasing Lofty Yields
While it may seem only logical for incomefocused investors to pursue stocks with the highest dividend yields, those stocks may have some problems of their own. First of all, very high dividends can often be unsustainable. Indeed,
dividend yields are often highest just before they are cut or eliminated.
Investors who care about total return should also know that the highest-yielding stocks often underperform by that measure. For example, the highest-yielding global dividend stocks in the MSCI ACWI have consistently underperformed the index as a whole over the last 10 years (Figure 1). One explanation for this is that companies paying too high a dividend may leave themselves short of cash to finance future growth. Research also shows that companies that steadily and incrementally grow their dividends over time tend to outperform highyielding stocks with no dividend growth.
These are all reasons why dividend investors should consider a company’s dividend payout ratio as well as its dividend yield. Our historical analysis across a variety of global markets shows that companies with the best long-term performance were those combining attractive—but not ultrahigh—dividend yields with relatively low payout ratios . Based on our research, the “sweet spot” is a payout ratio in the 30-60% range—a percentage high enough that companies can commit to delivering regular, meaningful cash payments to shareholders, but low enough that they can reinvest capital for internal growth.
How Not to Invest in Dividend Stocks by ValueWalk.com