Dividends are all the rage right now as investors look for more stable strategies that pay regular returns. These small payments are fantastic for stable portfolios that are diverse and include a healthy mix of growth and storage stocks. Focusing on high dividend yields alone won’t be a guaranteed recipe for success and you should consider adjusting the course.
Dividends aren’t the most important factor when analysing stocks, especially ones you plan on holding long term. I’ve already covered how focusing solely on dividend yield can cause problems for your portfolio. The short recap would be a high dividend yield (and I’m talking higher than 5% as a safety rule) could be a sign the stock is performing poorly.
By focusing too heavily on dividends and yields, you could enter the trap of buying a low-value stock. Higher yields typically translate into lower valuations, which in turn could represent weaker growth and expectations from other (and more experienced) investors.
Another metric to keep an eye on is the dividend payout ratio, which should be as low as possible unless it’s a REIT or some other specific type of company. Stable companies with solid fundamentals, a safe payout ratio, and reliable dividend growth are known as dividend aristocrats.
Don’t forget growth stocks
In the same vein, it’s important to not overlook stocks that do not pay regular dividends to investors. Growth stocks rely on foundations, potential, and a great product. A 5% dividend yield is fantastic for passive income, but compared to a stock that grew by 10% and has no dividend it’s a less fruitful investment.
It all comes down to creating a healthy diverse investment portfolio. Using my investment portfolio tracker, you can manage multiple stocks, sectors, and securities. You’ll be able to track how exposed you are to particular conditions to help weather any future storm.
Dividend stocks can be risky
We’ve seen countless examples of companies struggling to meet commitments on paying dividends. A financial crisis can put a strain on the bottom line of a company, which would be left with a choice to either borrow to cover a dividend payout or reduce/cancel it. Wells Fargo cut its dividend by a whopping 80% in 2020.
The higher the dividend yield and payout ratio, the more likely a company will be forced to act should it encounter issues. It’s important to consider even the slightly more boring yet well-established companies such as 3M (MMM) and Johnson & Johnson (JNJ). So what should you do when a dividend gets cut?
First, you to find out why the company reduced the dividend payments. Next, look at your portfolio and consider how this affects your returns, which is important if you rely on dividends as passive income. If the company is sound and this is a temporary measure (and you believe in its fundamentals) you could consider buying more.