Are you planning to invest in stocks? If so, it is important to know the advantages and risks of different styles of investing.
In this blog, we list some benefits and pitfalls of investing in dividend stocks. These will be helpful to you in making informed decisions regarding basic issues of philosophy and strategy.
- The dividend is not paper profit that can vanish in a bear market. Companies provide the dividend in cold, hard cash. And since most companies have a strong aversion to cutting their dividends, the average dividend is safe and reliable.
- Because dividends are generally presumed safe, the stock prices of companies that pay dividends tend to be less volatile. This means that dividend investors not only get part of their return in cash, but the price of their portfolio tends to exhibit far less volatility on a day-to-day basis.
- The whole purpose of any business enterprise (no matter how much growth potential it has) is to generate cash eventually. Companies that pay no dividends (and have no potential to pay dividends) are companies that are offering only promises. They seldom excel over the long run. And speculating in these companies usually leads to disappointment. Favoring long-term dividend stocks is not only the safest way to invest, but it is usually the most profitable.
The Pitfalls –
- Arguably, companies with higher dividends are of lower risk than companies with low dividends since part of the return they offer is in cash. But this is true only up to a point. Companies in dire straits many times see their dividend yields rise when their prices plummet. Many times, a high dividend yield is an indicator of the exact opposite of what many investors believe it is an indicator of.
- Few companies are actually obligated to pay a dividend. But in our modern capital market, investors expect (and many valuation models assume) any dividend a firm pays will continue indefinitely. As a result, any firm that cuts its dividend is usually punished severely by the market. Therefore, from the typical firm’s perspective, a dividend is almost as binding as a debt payment. What this means is that companies that fall on hard times and that do not pay a dividend, in a sense, are in a better position than those companies that do pay dividends. They can right the ship without having the extra burden of paying a dividend.
- Many times in stock investing, it is not the current level of profitability that really matters, but rather the The biggest returns accrue to those stock investors who identify and buy those companies with increasing dividends rather than high dividends. A company with a high dividend will have a hard time increasing that dividend; and it may even cut it. A company with no dividend cannot cut its dividend; and it just might pleasantly surprise and initiate a dividend. A company with a modest (or even no dividend) might be preferable to a company with a high dividend if chances are good that dividend will be increased.
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