Investors like high-paying dividend stocks because they can be a reliable source of income. But, they should avoid the temptation of seeking out stocks with the highest yields—simply because they have above-average yields. Here’s why.
With our Successful Investor approach, we advise investors to look for high-paying dividend stocks that will to pay off for investors if business and the stock market are good—but are least likely to hurt them during the inevitable periods when business or the markets are bad.
We’ve always placed a high value on a company’s record of dividends, mainly because it provides something of a pedigree for stocks we recommend. Many investors have come to share our high regard for dividends. However, some take it too far.
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Do not go to extremes with high-paying dividend stocks
Some investors put too much faith in a history of dividend payments. They think of a stock with a good dividend history as the next best thing to a government bond. But it’s nothing of the kind. It’s a good sign, but not the only sign you need to look for. It takes continuing effort to succeed as a so-called “buy-and-hold” investor. Rather, you need to learn how to “buy and watch carefully.”
The best dividend payers seldom if ever go through dividend droughts—periods when they have to cut or quit paying dividends due to setbacks within their company, their industry or the economy as a whole.
But remember that if you place too high a value on any single investment attribute, you may overlook signs of associated or offsetting risk. That’s something an investor needs to avoid at all times.
The biggest risk in high-paying dividend stocks
When looking for stocks with high dividend yields, you should avoid the temptation of seeking out stocks with the highest yields—simply because they have above-average yields.
That’s because a high yield may signal danger rather than a bargain—if it reflects widespread investor skepticism that a company can keep paying its current dividend.
Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.
Above all, for a true measure of stability, focus on stocks that have maintained or raised their dividends during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.
In short, a track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will be profitable for you in the future.
Strategies for investing in high-paying dividend stocks
Follow our Successful Investor rules over long periods and you’ll probably achieve better-than-average investing results. Even so, your results could be uneven in a variety of ways. They’ll vary widely from year to year. In some years, most of your profits will occur in only a few of the five economic sectors; you may lose money in one or more of the others. Some years, your U.S. stocks will provide most of the profits. Other years, your biggest profits may come from stock groups you hardly considered as groups such as stocks that trade on Nasdaq, or the biggest multinational companies.
Over long periods, you’ll probably find that a third of your dividend-paying blue chip stocks do about as well as you hoped, a third do better, and a third do worse. This is partly due to that random element in stock pricing that we’ve often mentioned. It also grows out of the proverbial “wisdom of the crowd.” The market makes pricing mistakes and continually reverses itself. But the collective opinion of all individuals buying and selling in the market eventually beats any single expert opinion.
Canadian blue chips are among the best high-paying dividend stocks
A company with a long-term record of paying dividends is generally one that is most deserving of the “blue chip” label in its traditional sense. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.
That’s not to say there won’t be surprises that affect every company in a particular industry. But well-established, dividend-paying stocks have the asset size and financial clout—including solid balance sheets and strong cash flow—to weather market downturns or changing industry conditions.
Canadian dividend stocks that meet our Successful Investor criteria offer both capital-gains growth potential and regular income. In fact, dividends are still likely to be paid regardless of how quickly the price of the underlying stock rises.
What’s more, dividends from Canadian companies come with a tax credit. This cuts your effective tax rate.
All in all, it’s realistic to assume dividends from blue chip companies will continue to contribute around a third of your total return.
Have you ever invested in a high-paying dividend stock where the company ended up cutting its dividend payment?
How much of your portfolio is dedicated to high-paying dividend stocks? Do you think you’ll increase or decrease that amount?
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