Should you keep dividend stocks in your portfolio? | How does the Dividend Yield Strategy Work? :
Dividend Deal : Dividend deal is a very important thing to focus on it maybe not the only thing to focus on while choosing a stock. But its importance cannot be understated and the core of the dividend deal strategy is the recognition that the overall returns from a stock is actually compounded or of two things capital appreciation and the dividend yield and any kind of historical analysis tells us that a fairly significant portion of the total return from a stock actually comes from the dividend yield.
How does the Dividend Yield Strategy Work? :
It may not be as exciting which is why a lot of investors don’t choose to focus on the dividend deal they look only at the capital appreciation but for long-term investors. Who looking at a stock more 15-20 year perspective for them the importance of dividend yield.
Actually shows up in the total return from the stock and it can be as high as 40 to 50 percent of the total return from an individual stock. Therefore keeping an eye on the dividend deal in assessing and total return from a stock over a long period of time.
Becomes very important there are many other ways which in which the dividend yield actually helps an investor one primary way is that the dividend yield actually becomes a shield in a bear market and we know that markets are cyclical and they go through bull and bear markets when markets are in difficult phases in bear markets and a high dividend deal.
Stock actually comes down the dividend yield keeps rising in percentage terms and very soon it reaches a point where it becomes attractive enough to hold just surely by virtue of the coupon or the dividend deal and therefore historical analysis tells us again that the high dividend deal.
Stocks actually whether bear markets far better than low dividend yield stocks in that it provides some kind of protection to the investor and therefore to ride out cycles in the market. Keeping an eye on the dividend yield is quite important there is a yet another reason, which is that when companies or management’s pay out dividends they are going against the chance of the prospect of allocations of capital the way to understand this is that when companies have very low dividend payouts.
They keep accumulating a lot of cash and capital in their reserves and at some point the reserves become so large that the management continuously continuously looks at avenues for deploying that capital sometimes. They make a rash acquisition or and any kind of movement like that can actually destroy a long-term shareholder value on the other hand companies which regularly pay out significant dividends don’t accumulate that much capital and the chances of misallocation are therefore much lower and finally.
When the dividend yield of a company in percentage terms actually rises to a significant level generally one can infer that the stock is on its way to becoming a value stock the price has corrected so much that the yield in percentage terms is becoming very high and often not always.
But often it is the cue for the stock to have become a value stock for all these reasons the dividend deal becomes a very important metric for any investor to monitor while taking an investment decision on a stock.
What Are The Common Pitfalls Of Dividend Yield Investing ?
The most common pitfall for dividend buying a high dividend deal stock is that the very rationale for paying out large dividends because often companies give out very large dividends because they don’t have very visible areas of organic growth. So what will they do with their capital they can’t deploy back in the business and therefore they give it back to shareholders.
So while it is a good thing to have high dividends from management’s one must always scrutinize the reason for that high dividend payout and whether it is because the management is failing to find a way to deploy that capital in the business this often means that growth for this company would be restricted going forward.
Because there is no capital going back into the business and the capital appreciation therefore will be very severely limited, so it will become like a coupon holding stock where he will make that coupon or the dividend but you will not make significant capital appreciation. So that’s a real threat which one needs to keep in mind also a corollary of this is that sometimes management’s use the dividend as a sort of Atkins consolation price that the capital appreciation for the last many years has been so tepid so anemic that shareholders are bound to be quite unhappy.
Therefore they seek to compensate for the lack of capital appreciation by giving out large dividends and investors generally don’t like to be in companies where the capital appreciation is very muted and therefore one should be careful about this fear that this is a consolation price and it will not create a lot of wealth for you going forward from capital appreciation.
And lastly the one thing which a lot of investors fail to understand while being attracted by the dividend is that there is a capital risk attached to buying a stock with a high dividend yield it is never to be confused with a bond with a fixed coupon. Which is what a lot of laid-back investors think a high dividend deal stock is a high dividend deal stock.
Like any the stock is subject to fall in the stock price and unlike a bond where in most cases you are more or less certain that your principal is safe and you can get that 7-8% coupon at the end of the tenure in the case of the stock.
There is a more significant capital risk attached to it which is an imperative for investors to understand so they should not think that the price does not fluctuate and it can only go up and do not come down and therefore they can take the coupon or the dividend with their capital safe and that I think is a misunderstanding which a lot of investors should shed while they’re looking at the dividend deal.
So in summary there are attractive reasons for considering the dividend yield but one should stay clear of jumping to major conclusions and be careful to look at the real reasons why the dividend yield is very high in a stock otherwise one might easily make up making an investing error.
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