3 Things You MUST Know About Dividend Investing

by Jeff Reeves | July 12, 2012 1:00 pm

3 Things You MUST Know About Dividend Investing

A lot of emails came in recently regarding this week’s article about “3 Unknown But Airtight Dividend Plays[1].” Many readers wrote in regarding high-yield stocks of their own — double-digit yields, in fact — asking for my 2 cents.

It was interesting to see how different perceptions of dividend stocks can be. Namely, the divergence between conventional dividend investing for capital preservation and income over the long term versus the current craze for seeking yield above all else.

So as a public service, allow me to point out three important facts of dividend investing:

The yield ONLY matters if it’s sustainable. Don’t just check out Google Finance or Yahoo! Finance and be fooled into thinking a company with a 10% annualized yield is going to deliver a 10% return on your investment via dividends.

The way most sites calculate things, a company trading for $10 could have a 10% yield if it paid 40 cents four quarters ago, 30 cents three quarters ago, 20 cents two quarters ago and 10 cents last quarter. That’s $1 a year, yes, which is a 10% annualized yield. But it’s not the same as getting 25 cents a quarter consistently with the promise of the same payday (or higher) going forward.

A big dividend does NOT guarantee low risk or big profits. As InvestorPlace contributor Charles Sizemore recently quipped in an article warning of chasing dividends in a vacuum[2], “What’s the easiest way to find a stock with a 10% dividend yield? Find a stock yielding 5% and watch its price get cut in half.” After all, what’s a 10% dividend if shares drop 30% or 40%?

Dividend investing is inherently LONG TERM: If you’re planning on buying a stock with a 10% yield and justify buying it based on the dividend, you better be prepared to hold it for 12 months. Maybe more, depending on dividend dates.

That’s because yields are annualized, meaning based on one year of paydays. If you buy today and sell in three months, you may not get a single dividend. That’s not to say you can’t swing-trade stocks that pay dividends … but if you’re buying because of the payouts, be realistic about how long you have to hold stocks to get paid.

Everybody wants big yield these days, and with good reason. CDs and “high yield” savings accounts offer a meager 1% return. Treasuries are around 1.6% for the 10-year. If you can get a 3% or 4% yield from a stock, it beats just about everything else out there.

Still, you have to be honest with yourself about what your strategy is with dividend stocks. If you’re really after income and yield, know that sustainability of that dividend is crucial and long-term holding periods are mandatory.

And even then, you’re not guaranteed profits.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[3] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.

Endnotes:
  1. 3 Unknown But Airtight Dividend Plays: http://investorplace.com/2012/07/3-unknown-but-airtight-dividend-plays/
  2. warning of chasing dividends in a vacuum: http://investorplace.com/2012/05/dont-get-caught-chasing-a-dividend/
  3. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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