High Dividend Yield Strategy? Yes, But!
When times are tough, there always seems to be
increasing talk about the high dividend yield strategy. It’s an approach that, if implemented
properly, produces better than average returns over time relative to the level
of risk accepted by the investor. Although
these stocks will usually underperform in strong markets, their resistance to
price erosion in weak markets is what gives them the edge.
Over extended periods of three to five years or more,
portfolios that include a broad selection of high dividend yield stocks will
usually be good choices. One of the keys
is the phrase “broad selection”, at least a dozen if not twice that many.
The analysis of individual high dividend yielding
stocks begins with a comparison of company earnings and dividends paid. That’s known as the payout ratio. If dividends paid are well covered by company
earnings and are likely to continue being well covered, that’s a good
sign. But, especially with cyclical companies
such as the construction industry, the earnings pattern tends to be choppy and
there may well be times when the companies’ profits fall short of what’s being
paid as dividends to investors. Some of
these companies are very well financed, enabling them to maintain their
payouts. Others have no choice but to
eliminate their dividends.
In those cases, an apparently generous dividend yield,
which might be in the high single digits, could be misleading when more
challenging times lie ahead. A further
problem is that when dividends are stopped, funds holdings stocks with high
dividend yields have to sell their holdings.
The common routes for those seeking high dividend
yield holdings are open-end mutual funds and exchange-traded funds. There is a wide selection available and, in
most cases, with expense ratios that are quite reasonable. Some emphasize the longevity of dividend
payments. Others focus on the growth
rate of dividends. And then there are
those that credit consistency of dividend increases over extended periods.
Investors who prefer a simplistic approach to
portfolio construction could certainly include one of these high dividend yield
funds as the domestic equity component of their holdings, possibly supplemented
by a high dividend yield international fund.
As we move ahead through the current economic cycle and interest rates
rise further, the addition of a total bond market fund should also be
considered.
N. Russell Wayne, CFPÒ
Any questions? Please contact me at nrwayne@soundasset.com
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