There are different strategies you can employ in the course of building an investment portfolio. And one of those strategies could involve loading up on dividend stocks.
The great thing about dividend stocks is that they provide two opportunities to make money. First, there’s share price appreciation. Over time, the value of your shares can grow, making you richer.
Then there are those dividends themselves. Not only can they serve as a steady income stream, but you can also reinvest your dividends to grow additional wealth — either in the same company that pays you those dividends, or in another company.
In a recent survey by CNBC Delivery Alpha, 30% of investors say that right now, they’re most likely to buy stocks with a high dividend yield. But while that’s not necessarily a poor choice, it’s important to proceed with caution when chasing after higher-than-average dividends.
The downside of high-yield dividend stocks
It’s easy to see why dividend stocks with higher yields might appeal to investors. But there’s a danger in banking too heavily on dividend yields alone when choosing stocks for your portfolio.
For one thing, a higher dividend yield does not guarantee strong share price growth. Furthermore, while a company’s dividend may be high right now, it’s not guaranteed to stay that way.
The dividends companies pay aren’t obligatory. And while many companies do have a long history of paying strong dividends, they can also reduce or eliminate those dividends when financial circumstances warrant that.
Not only that, but when companies cut dividends, it tends to negatively affect their share price. So in that regard, dividend stock holders face a double whammy — a reduced dividend, and also, shares that could evolve to be worth less money.
Furthermore, it’s important to recognize that a higher-than-average dividend is not necessarily an indication of long-term financial strength. In fact, if a company has a much higher dividend yield than its competitors, that’s not necessarily a good thing.
Remember, a dividend is a portion of a company’s profits that’s being paid out to shareholders. Any money that’s given to shareholders is money that cannot be reinvested.
If a company is paying a higher-than-average dividend, it could serve as a red flag that that business’s growth opportunities are limited. And that means that your shares may not gain as much value as you’d like them to in the long run.
As such, while there’s nothing wrong with looking at companies paying high dividends, dividend yields should not be the only factor you take into consideration. You should also look at a company’s long-term prospects and opportunities.
Along these lines, it pays to look at a company’s dividend history if you’re going to specifically chase stocks with a higher dividend yield. You may be better off investing in companies that have consistently raised their dividends over time.
Proceed with caution
To be clear, dividend stocks can be a solid investment, and it’s OK to look at companies paying higher-than-average dividends. Just be sure to assess the big picture before adding them to your portfolio.
10 stocks we like better than Walmart
When our award-winning analyst team has an investing tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
They just revealed what they believe are the ten best stocks for investors to buy right now… and Walmart wasn’t one of them! That’s right — they think these 10 stocks are even better buys.
Stock Advisor returns as of 2/14/21
The Motley Fool has a disclosure policy.