This year, the 100 stocks in the Standard & Poor’s 500-stock index with the highest dividend yields are up an average of 3.7% before dividend payouts, according to Birinyi Associates. The 100 lowest-yielding stocks are down an average of 10%.
Is this a good idea? I understand the move to dividend-paying stocks—companies that admit they don’t know what to do with their excess cash are almost by definition better-run than those that hoard it without announcing future plans for its use (hi, MSFT!). And some companies have a lot of excess cash right now.
But there is a difference between paying a dividend because it’s the best use of funds for your investors and having a high dividend yield. Don’t believe me? Ask Bank of America shareholders ($2.56 Annual Dividend, just under an 8% yield) ca. 2008:
Of course, banks might be the except. But here’s the past five years of Toronto Dominion, which was paying around a 3% p.a. Dividend** around the same time period:
What would have happened to your overall investment if you had gone for the higher-paying firms? It’s not pretty:
I like dividends; they’re an admission from a firm that it doesn’t know better than its owners what to do with some of its cash. But high-yielding dividends are often a sign of bad management giving away “excess” cash in good times.***
The first rule of finance: when something appears too good to be true, it probably is. Caveat emptor and may all your investments for 2012 be good ones.
*The graphic scale and dividend amounts were distorted somewhat by the 10:1 reverse split earlier this year.
**An annual dividend of US$2.28, with the stock trading around US$70-75 per share.
***This is not an unusual story, sadly. The collapse of LTCM, for instance, occurred after the fund gave much of its investment monies back to investors and then count not remain solvent for so long as the market remained irrational. (The contemporary equivalent is MF Global.)
(cross-posted from skippy the bush kangaroo)