Due to their regular cash flow and perceived lower risk, high-dividend paying stocks are popular with investors. But are they a smart option? In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer explains the basics of high-dividend paying stocks and shares why we don’t recommend exclusively investing in them.
Jared Kizer: All right. So today I’m going to talk about high-dividend paying stocks as an investment strategy, of course related to the stock portion of the allocation and get into why we generally don’t think that’s a good at least exclusive approach to the stock allocation portion of the portfolio.
What Are They, and Why Are They So Popular?
Jared Kizer: So really briefly on what high-dividend paying stocks are. So stocks can pay a dividend, so this is just a cash flow that you could earn over the course of the years we’ll talk about here in a second. Not all stocks actually pay dividends, and that’s going to be one of the critiques of this approach. But for stocks that do, they may pay, for example, a 5% dividend yield, which means that the stock is trading at $100, that over the course of that year, you can reasonably expect all else equal that you’re going to get paid $5 of cash.
Why Don’t We Recommend Focusing on High-Dividend Paying Stocks?
Jared Kizer: So because investors tend to be tempted toward cash paying strategies, understandably, to some degree, we do tend to see a lot of questions come in about why not specifically focus on high-dividend paying stocks. So let’s cover the three kind of critiques of this type of approach to investing again, at least as an exclusive approach to investing.
Reason #1: Stocks Will Be Stocks
Jared Kizer: So first point being that high-dividend paying stocks are still stocks, meaning they’re going to be responsive like all stocks are to what is going on in the broader economy and of course, specifically what’s going on with those companies. So you don’t necessarily shed yourself of the risk of stock market investing because you do tend to see if the overall stock market is down a lot, that these high-dividend paying stocks tend to be down as well. Very related to this first point is that because these are dividend payments, they’re at the company’s discretion. So you can, you know, own a stock that’s paying that 5% dividend yield, company hits a rough patch and they eliminate the dividend or cut the dividend in half and all of a sudden you’re not receiving the cash flow that you expected you would. So, there’s a good bit of uncertainty there.
Reason #2: Many Companies Don’t Pay Dividends
Jared Kizer: Second point which relates to changes in the market dynamics is it used to be the case 40 or 50 years ago that a very, very large fraction of stocks paid dividends. We’ve seen that change massively over that period of time to a point where a relatively small fraction of companies, certainly compared to years past actually pay dividends. So if you’re focusing only on those types of stocks, you’re likely going to be more concentrated and potentially focusing on specific sectors and just not be as well diversified as we would like investors to be.
Reason #3: Value Investing Offers Diversity
Jared Kizer: Finally, you’ve heard us talk about value investing, which is the concept of buying stocks that are trading at low prices relative to earnings or the book value of the company compared to the broader market. We think that can be a very sensible approach to stock market investing for a lot of investors. And that approach also tends to own the higher-dividend paying companies as part of that broader approach. So it doesn’t only own those companies, but those companies do tend to frequently fall in the value bucket. So that’s a way to have these companies represented in a stock allocation but not be exclusively focused on those companies. So hopefully that’s a good perspective on the way that we think about high-dividend paying stocks. If you have additional questions you like for us to tackle, feel free to reach out to your advisor or click the link below and submit questions in that way.
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