Buying high dividend paying stocks as a good long term strategy?
A interesting question was put to me today. Is buying high dividend stocks a good long term strategy?
Here are my thoughts:
The way the stock market compares stock dividends is through dividend yield. Dividend yield is a company’s next 12 months’ dividends divided by its current share price. The proposed dividend is not important its the ratio to the share price. This gives you a more accurate comparison across all stocks.
For example Bank of Ireland dividend yield: Share price at yesterdays close was €5.90 and the proposed dividend is currently 63c a share. This gives a dividend yield of (63/590) or around 10%.
In an ideal world the dividend yield should be factored into the share price. This would result in higher dividend paying companies having a higher share price. But there are exceptions to this:
1. The general profile of dividend paying companies is safe boring companies that need dividends to attract investors. But we have a situation emerging at the moment where dividend yields are too high. As mentioned above BoI have a dividend yield of 10%. The dividend yield increase is due to the drop in share price. I say these yields are too high because in effect they are abnormal. BoI’s yield will not be that high next year and may even be a lot lower than traditional yields. If the dividends drop in future years so will the value of you investment. Beware of dividend yields that are too high!
2. Dividends come from a companies cash reserves. If you are going to invest in companies based on their dividends, you should first analyse it’s future cash position. Dividends can evaporate very fast. Again if current market conditions prevail BoI may not have the cash to distribute next year. This could mean there dividends fall back to 3/4% or less dividend yield. A companies future outlook is important.
Note: If a company revises it’s proposed dividends you are left not just with less dividends, but most likely a lower share price. In effect a double hit.
Getting back to the original question is it a good ‘long term‘ strategy?
There are several funds that invest in companies with high dividend yield. I understand that they have produced steady returns over the last few years. Fund managers go through companies dividends in detail and analyse who has the best historic, current and likely future earnings.
Hibernian High Yield Fund for example has performed well over the last five years (7.1% growth pa) but poor in the year to date (-16.5%).
In Short:
Again I would like to stress I am not an expert, this is my personal opinion.
Traditionally holding stocks with a high dividend has been a defensive position in bear markets. This is not for short or medium term investors, you are looking at 5+ years. It’s important to ensure that there are likely to be high future dividends from any company you invest in. Analyse the prospectus and promotional material from funds that invest in high dividend yield stocks. See here. This will give you an idea how this market has performed historically. Commentary from the fund mangers can be interesting. Also the funds provide a diversified portfolio, so it may be less risky to invest in them than in individual stocks.
Would you invest in high dividend yield stocks? Leave a comment.
theirishinvestor
September 11th, 2008 at 5:34 pm
Slight change made to point one above as clarification. Safe stocks distribute dividends to attract investment, but when the dividend yield gets too high this can be an indication that there are problems with the stock. It may have gotten too risky!
September 17th, 2008 at 4:59 pm
Would it be recommended in todays climate investing in index funds?
September 18th, 2008 at 9:03 am
Ian, I presume you mean indices like the S&P 500 and FTSE 100.
For readers:
An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions. So rather than invest in a individual stock you are investing in the market as a whole. Your gain or loss is determined by wheither the market goes up or down.
Ian it is widely accepted that we are in a worldwide recession. The upshot of this is that most markets are going down. But even in a recession some sectors do well. Energy and renewable energy companies have a good future. There are index funds that track these sectors.
It might be better to target a sector you feel will do well rather than a broad market like the S&P500 or FTSE 100.
We are in for a rocky year or two. So if you are making an investment you will probably need to look at a three year plus timeframe.
September 18th, 2008 at 2:54 pm
Yes thats what I was looking for thanks.