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What’s the point of investing in dividend stocks if it’s not to earn high-dividend yields?

The main appeal of investing in dividend stocks is definitely to build a passive source of income. Too often, low-yield dividend stocks are dismissed to the profit of high-yield dividend stocks. Investors are often greedy and look at short-term income. Most dividend stocks are paying a dividend yield between 2% and 4%. In my own terms, stocks paying higher than 4% are called high-yield dividend stocks.


We call the high-yield dividend stocks a dividend trap as many investors buy these stocks for the yield but don’t look at the fundamentals. Therefore, they are receiving high-dividend payouts, but the underlying value of their investment is melting down faster than a GI Joe in the microwave. Warning: it’s not because a dividend is higher than 4% that it’s automatically a dividend trap…

High-Yield Dividend Stocks – There Must Be A Reason

The calculation of the dividend yield is as follow:

dividend payout ratio


  • A dividend payout increase
  • A stock price decline





But rather:


Don’t fall for the high-dividend yield trap. There are always fundamental reasons why a stock is paying a high dividend yield. Unfortunately, this is often because the stock has dropped due to disappointing financial results.

A High Dividend Yield is Not Enough

Some investors might have the reflex of thinking: “Hey! Why not buy this stock with a 10% dividend yield, I’ll get all my money back within 10 years!”. Sure a double digit dividend yield is quite tempting. When you look at government bonds paying less than 2%, a 10% dividend yield seems like the end of the rainbow. Well it could really be the end for the company paying it.

Would you like to buy a stock that pays a 16% dividend yield for example? This is a pretty high-dividend yield, right? But what if the stock chart for 8 months looks like this:

(click to enlarge)Radio Shack

As you can see, this stock is down 70% since the beginning of the year. No wonder the yield has jumped to 16%. Chances are that if you keep holding this stock, you will lose pretty much all your capital based on the hope of receiving a 16% dividend. Even at this rate, you would need a little bit more than six years to recover your capital through dividend payouts. Do you really think that this stock can hold its dividend for the next six years or so? The most probable scenario in this case will be a dividend cut announcement followed by a restructuring. Hopefully, the company will be able to get back on track. If not, you will be losing a lot of money on this trade. In both cases, I don’t think the high-dividend yield justifies you taking such risks in your portfolio. Wonder which stock that is, right? It’s Radio Shack (RSH).

How To Build A True High-Yield Dividend Portfolio

As you can see, there is no magic behind a high-dividend yield. It’s either due to a stock drop (bad signal) or an aggressive dividend raise strategy. In most cases, when a company agrees on higher dividend payouts, it’s because the fundamentals are doing great. This is why the stock price follows upon such good news.

So how can you build the famous 6-7% high-dividend yield portfolio you dream about for your retirement? By using a long-term investing strategy based on dividend growth. What you should be aiming for in such a portfolio is not an immediate high-dividend yield but rather to pick stocks with the good habit of increasing their dividend each year.

Then, the most important part, don’t calculate your dividend payouts divided on your current market value to calculate your dividend yield. Use your cost of purchase. Here’s a quick example:

Let’s use the Intel (INTC) example. INTC’s dividend payout was $0.08 a share back in 2003.

(click to enlarge)INTC

The price on January 3 was $16.54. The $0.08 dividend payout was equal to a 0.48% dividend yield. This is far from being interesting, isn’t it? Anyways, it’s pretty far from being considered as a high-yield dividend stock! However, in 2012, INTC will be paying $0.87 per share ($0.21 for 2 quarters followed by an increase to a $0.225 quarterly dividend). On August 16, 2012, the stock was trading around a price of $26.52. The dividend yield showed on any investment websites would be 3.80% ($0.87 / $26.52). 3.80% is already a pretty good dividend yield but it’s not high enough to be considered as “high yield.” If you have been holding INTC for the past 10 years, your dividend yield on this stock is not 3.80% but 5.26%. The 5.26% is the yield calculated on your COP. Now this is what you need to build with your portfolio; long-term dividend holding positions that will generate higher and higher dividend payouts.

Disclaimer: I hold shares of KO and INTC.

Source: High-Dividend Yield Stocks: Here's What May Be Wrong With Them
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