Blogger bullbear and High Dividend Yield Stocks (2)

The chatbox had a pleasant surprise this morning. When bullbear was away from my chatbox, he turned into an active blogger! Personally, it is nice to see him blog, because he is a prolific chatter, and shared many of his own thought provoking quotes and summaries, which usually resulted in lively discussions. However, being a chatbox, postings quickly gets drowned in a sea of other chats which requires frequent reposting with its own "side-effects", so, I have recommended to him before to consider blogging so that his quotes becomes more permanent. It is good to see him finally blogging. So, from now on, we should refer to bullbear as a fellow "blogger" and not fellow "chatter" and welcome to blogging bullbear. Noted that besides being a prolific writer, bullbear also have three (3!) blogs here:
- http://myinvestingnotes.blogspot.com/
- http://klsecounters.blogspot.com/
- http://klsecountersii.blogspot.com/

Anyway, further to my earlier article on High Dividend Yield Stocks, we have another discussion this morning where bullbear shared with us his personal experience on High Dividend Yield Stocks. Whilst he did not elaborate in detail his own practice, the ardent student will surely find plenty of hints by looking at bullbear's articles. Anyway, I sincerely hope bullbear will one day consider sharing his experience in his blog.

As with any investing strategy, there will always be pros and cons to holding a sound portfolio of High Dividend Yield Stocks. Most proponents will tell you the benefits first, so, let me be different and tell you the pitfalls first:
-- Poor / incorrect stock selection. If the wrong stock is chosen, you'll end up with reduced dividends and a battered share price such as my Bank of America example in my previous article.
-- Poor allocation by stocks. Too much monies in the poorer performing stock, and your total portfolio could underperform F.D. despite getting all the right stocks.
-- Poor diversification. Too much concentration into too few stocks (say 1 or 2), and these 1 or 2 stocks might end up being a dud, with portfolio losses.
-- Poor cash/stock portfolio % allocation. Under-exposure in bull markets could end up under performing. Conversely, over-exposure to equities during bear markets will also end up with poorer performing portfolio, despite the intention to hold such stocks in the long term. Many stocks looks good on paper over the "long term", but in a crisis, some goes bust.
-- Temptation to tweak the system to get better returns. E.g. trying to be "smart" and "market time" and end up selling the good stocks, keeping the lousy stocks, with lower portfolio returns (this happens often to investors inexperienced with market timing)
-- etc.

In other words, the potential pitfalls are many, although not completely insurmountable to an intelligent, disciplined and dedicated investor.

However, the underlying logic behind it is good if this is implemented properly.

Typically, when implemented properly (as bullbear shared), these stocks - at the right time - can be purchased with 4% dividend yield which already beats Fixed Deposits.

Then, over time, provided the portfolio is sufficiently diversified in a group of above-average, good businesses that yields a generally increasing earnings and cashflow over time, the dividends paid out (assuming management with integrity and history of consistent and transparent dividend practice and policy) should also increase over time. On average it is not unreasonable to expect higher dividends that matches at least inflation rate, or even higher, and this compares favorably against a Fixed Deposit interest which is flat over time and whose real value is constantly eroded by inflation.

Furthermore, in theory, retained profits increases the value of the business, potentially increasing its share price.

When executed properly in its entirity consistently with discipline, it can be a rewarding experience with generally little active effort and no real need to monitor the markets every day.

However, besides its pitfalls, the type and personal character of investor is equally important.

Such a person must have the character and temperament for this type of strategy. If someone is itchy to trade, such a strategy would generally work against his/her personal character. It is just as important to make sure that the strategy fits with one's personal character and objectives.

It is pertinent to ask - as bullbear has done - why is it that there are so few of such investors around, if such a strategy is indeed superior - arguably vastly superior - than investing in F.D.?

There are many possible answers to this, and to me, I think it boils down to the following factors:
-- Many DIY investors & traders have strategies that targets to exceed F.D. by a long shot, so, a High Dividend Yield Strategy is not exactly earth shaterring. They are willing to put in the time and effort.
-- The benchmark is rather low. Even passive index investing is expected to beat F.D. rates over the long term with even lesser effort.
-- It is only human nature to want quicker returns, notwitstanding failures. Further analysis will usually reveal that this is very much linked to the "greed" factor. Who doesn't prefer more money now, compared to up to a year waiting for the dividend cheque to arrive?
-- lack of knowledge, discipline, and other pitfalls described above.

Notwitstanding the criticisms, I believe that the strategy can work well for the right individual. Personally, I have also practiced this before, and I did not have a bad result. Certainly, no complaints. However, I have move on to other strategies which I believe is a better fit for me personally. But I don't believe in one size fits all type solution for all times. Human beings are much more complex. We all have different objectives and temperament and resources that we brings to the table, even over time. Anyway, if you are interested to know more, I'm sure bullbear would be happy to share with you more about this.

Also, do also check out fellow blogger Moolah's postings which highlights some examples of the "false pretenders" of High Dividend Yield stocks, such as this one on Uchitech here - http://whereiszemoola.blogspot.com/2007/09/review-of-uchi-again.html.

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!