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Tuesday, October 7, 2008

High Dividend Yield Stocks

This morning, chatter "bullbear" shared some thoughts on investing in high dividend yield stocks. It's a common topic since who doesn't like a high dividend yield? This of course ass-u-me-s that high dividend yield can be maintained during periods of crisis or difficult business periods.

But the critical question is -- can the high dividends be maintained in future?

Supporters will point to the past and say "Just look at the high dividends paid in the past".

But this begs several obvious questions:
-- does the past guarantee the future?
-- what about the earnings outlook?
-- what happens if earnings drops by say half?
-- what will happen to dividends when earnings drop?

One of the stocks I was looking at was Bank of America, which is now the 2nd largest bank by market capitalization in the U.S.

Until today's announcement, the dividend yield looked attractive. Dividend was $2.56 last year, price at the time of writing is around $28, giving a dividend yield of around 7.4%!

Except the price of $28 represents 14% drop from prior day closing.

And the reason for the price drop is largely because of 2 main reasons: First, third quarter earnings are expected to drop by a whopping 68%!! And as a result of the earnings drop, BAC is expected to cut dividends by a whopping 50%!!

So, I guess the "high and attractive" 7.4% dividend yield is about to become an "much-less-exciting" 3.7% dividend yield going forward.

So much for investing in high dividend yield stocks blindly.

Of course, BAC is just one example. There are always other counter-examples in a different time, in a different place or sector. The key is careful selection. Never invest blindly in high dividend yield stocks. Look for earnings growth, solid cashflows, dividend growth, good past history and future prospects, and good pricing. Unfortunately, one or two of these are too-easy-to-find and touted-by-too-many-people-with-vested-interest, whereas, finding all 5 of them are much, much harder.

Good luck!

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