Are high dividend stocks a good investment? Yes... and no. Here’s what you should know before you jump in.
Are high dividend stocks a good investment? It’s a question we get a lot. But like many things in investing, dividends don’t exist in a vacuum. Just like the price of a stock or the profitability of a company, dividends are influenced by multiple factors. Certainly, these stocks can be good additions to a portfolio. There’s nothing wrong with extra money flowing into your account.
Higher yields come with higher risks though. Many of these stocks’ yields are so high because they’re struggling, and they may even have to slash their dividends soon. It’s also true that investors often have to choose between dividend growth and dividend yield. Some stocks have the ability to raise their dividends every year, but many of these have low starting yields. On the other hand, high-yield stocks often pay the same dividend for years on end, as they don’t possess the ability to raise their dividends from the current level.
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What is a dividend yield?
First, what is the dividend yield? The dividend yield is the annual dividend per share divided by the price per share. A $10 annual dividend on a $100 stock would give you a 10% dividend yield. Let’s play with that math, though. Say the stock price rocketed to $200 per share. Your dividend yield is now 5%. On the other hand, if the stock price drops to $50 per share, your dividend yield goes up to 20%.
On the surface, a 20% dividend yield sounds pretty great, right? But given how we got to that number, the 5% yield looks a bit better. Never mind the fact that the 20% dividend probably won’t last if that share price keeps dropping. In other words, never base your investment decisions on a number without doing your homework. Similarly, let’s not jump to any conclusions about high dividends just yet. There’s more to look at.
Are high dividend stocks a good investment? Let’s examine the evidence.
Are high dividend stocks a good investment? With what we have so far, they don’t look promising. For example, Macy’s (M) previously topped the list of the highest-paying dividend stocks in the S&P 500, but that doesn’t make it a good investment. The stock is in the struggling retail sector and has lost almost 90% of its value over the last several years, as consumers steer away from brick-and-mortar retail stores and revenues decline.
On the other hand, more reasonable, but still high dividends are out there and look like buys. Walgreens Boots Alliance (WBA) is a good case study. Goldman Sachs analysts recently classified WBA as a “dividend all-star,” and for good reason. The second-largest pharmacy store chain in the U.S., WBA’s dividend yield has risen at a compound annual rate of nearly 7% since 2015, and it has a multi-decade record of continual dividend increases. While the company’s earnings have been flat in recent years, revenue continues to grow by around 5% per year, and its earnings tend to hold up well during economic downturns.
Here’s one more example of a company with a lower dividend yield that has a far more promising outlook than Macy’s. Procter & Gamble (PG) is a consumer staples manufacturer that sells its products in more than 180 countries and generates over $70 billion in annual sales. It has a huge product portfolio with a number of category-leading brands. Just a few of its core brands include Gillette, Tide, Charmin, Crest, Pampers, Bounty, and many more.
Since consumers always need things like toothpaste, razors, diapers, and laundry detergent, P&G is a defensive stock that should thrive regardless of what’s happening in the overall economy. And though its dividend yield is under 3%, the company has paid a dividend to shareholders for 130 years, and it has increased its dividend for 64 consecutive years.
So what does all this mean? Are high dividend stocks a good investment? The answer is still, “It depends.”
What is your opinion of high dividend stocks? Do you think they’re worth taking a chance on?