Are High Dividend Stocks Always Worth Investing Into?
Introduction
The simple and oft-repeated advice to focus solely on dividends while making investment decisions can be misleading. This article explores the complexities associated with high dividend stocks and analyzes their value as investment choices. By debunking common misunderstandings, we aim to provide a comprehensive perspective on whether high dividend stocks are always worth the investment.
The Myth of Dividend Focus
Many investors incorrectly assume that a high dividend is a sign of a dependable investment. However, this belief can be dangerous. As stated in the source, 'Focusing on the dividend is the biggest mistake investors can make!'
Why? Free Cash Flow (FCF) and Net Income are the true indicators of a company's profitability, not its dividend payout. A company's ability to maintain or increase its dividend payments is contingent upon its profitability, and any change in this can drastically impact the dividend. Therefore, simply aiming to maximize dividends can lead to a poor investment if the underlying profitability declines.
Dividends vs. Stock Price Stability
Dependent on dividends can also be risky because of the inverse relationship between stock price and dividend yield. If a company's stock price drops for a legitimate reason, the dividend becomes artificially higher. This illusion can lure investors into holding onto a poorly performing stock. Additionally, companies may cut dividends during economic downturns or when facing financial difficulties, leaving investors with a disappointing outcome.
Alternative Investment Strategies
Instead of focusing solely on dividends, it is crucial to consider a more holistic view of the stock. Factors such as the company's profitability, growth potential, debt levels, and management practices should all be taken into account. For example, some investment professionals advocate for specific dividend growth stocks as attractive long-term investments, as they provide both income and growth potential.
The Role of Dividends in Investment
While high dividend stocks can be a beneficial choice for investors seeking income, it is not a guarantee of a good investment. As noted, companies that pay dividends often prioritize profit over growth, making them more risk-averse and potentially less dynamic.
Comparative Analysis
Understanding that dividends are payments to investors out of FCF, rather than reinvestment, can alter how investors perceive stock returns. Simply looking at a stock's price change does not provide a full picture of its performance. Total return, which includes dividends, is the accurate measure for comparison. Moreover, considering the reinvestment of dividends can provide a more nuanced view of a stock's performance over time.
Historical Example: Ford
To illustrate, consider Ford, a company with a strong history of dividend payments. If an investor purchased Ford for $1.00 per share 40 years ago, they would have earned dividends for 16 out of the last 20 years. The latest quarterly dividend of $0.15 in 2019 resulted in a current yield of about 6.52% when the stock price was around $9.20. This yield, though high, reflects the stock's historical performance rather than a guarantee of future success.
Nominal Yield vs. Current Yield
Nominal yield is a historical measure of the initial dividend payment when the stock was purchased. In contrast, current yield represents the dividend yield based on the current stock price. Many investors overlook the current yield, which is the metric used in practice to assess the value of the dividend.
Conclusion
The assertion that high dividend stocks are always worth investing into is misleading and inaccurate. While dividends can indeed be a significant factor in an investor's decision-making process, they should not be the sole focus. It is crucial to consider a range of factors, including profitability, growth potential, and management practices.
Final Remarks
Dividend stocks can be a very good investment for those seeking income, but they should be evaluated based on a broader set of criteria. While it is true that high dividend stocks can be a worthwhile choice, they should be carefully analyzed to ensure that they align with an investor's long-term goals and risk tolerance.
Disclaimer
This material is not a recommendation to buy, sell, hold, or roll over any asset, adopt an investment strategy, retain a specific investment manager, or use a particular account type. It does not take into account the specific investment objectives, tax, and financial conditions, or particular needs of any specific person. The information provided is general in nature, not intended to be tax, legal, or accounting advice, and based on current laws, which are subject to change at any time. This information has not been endorsed by any government agency.