Are high dividend stocks a good investment?
First things first, what is dividend yield?
Dividend yield is the dollar amount per share of dividends received in a year, divided by the price of the stock.
Those who AGREE that high dividend stocks are a good investment:
Those who caution against high dividend stocks:
According to Billy Ko, a high dividend yielding stock might look enticing but one has to dive in deeper to analyse the financials of the company.
- Is the dividend payout taking up a large percentage of their revenue/profits
- Are they generating a positive cash flow
- What are their strategies moving forward
Rickermers Maritime listed on SGX is one good example of a high dividend stock that went from Hero to Zero.
Also further elaborated on by Richard here:
For example, Starhub with a forward dividend yield of 10.53%. To put that in perspective, REITS, a form of trust that has to payout 90% of their income to unit-holders, have a dividend yield of about 5~8%.
Business survival is the most important. At times, a dividend cut may be painful in the short term, but if it can ensure that the firm has money retained earnings for reinvestment and payment of debt, I think as an investor I would rather have 1~2% lesser dividends for a few years if it didn’t mean that the entire stock price would drop 20% if it didn’t cut dividends.
If you’re still not convinced, here is how you can analyse why you should proceed with caution for high dividend stocks.
Here are 2 metrics
- Dividend Payout Ratio and
- Dividends as a percentage of free cash flow
Dividend Payout Ratio
The dividend payout ratio is simply the percentage of net profits that are being paid out to shareholders. To find this, simply take dividends paid out divided by net profit as shown.
The lower the figure, the better, since this means that the company isn’t taking out too much of its net profits for dividend payments, and the dividends can sustain.
Dividends as Percentage of Free Cashflow
FCF measures cash flow that is available to lenders and shareholders after the cash needs of the business have all been settled. This is a powerful measure since it looks at what kind of cash remains for non-business operating activities.
The formula shows how to get FCF. To get the percentage yield, just take the dividends divided by the FCF. Again, the lower the percentage the better.
That said, I think it’s clear that one should exercise discretion when dealing with high dividend stocks.
How then can you more carefully invest in high yielding dividend stocks?
Let’s face it – all investments have risks and it is highly unlikely or almost impossible to invest with 0 risks.
1. There are some ways that can help to reduce your risk exposure.
Learn how to evaluate the company’s financial health as well as its future prospects
When evaluating a company, use a variety of indicators and not just rely on one indicator or ratio as it will not be able to paint a complete picture of the company’s financial health.
2. Avoid putting your trust in a single company by using mutual funds.
Also, be wary of companies that have high dividends but low retained earnings per share.
This may differ across industries. It may vary from industry to industry. In general, companies must reinvest some profits to make sure that they can continue profitable operations in the future, and that is impossible if there are no retained earnings.
All this information can be found in the company’s balance sheet.
Assess your situation and make the right call!