Over the last 30-40 years, stock investors have taken plenty of risks when it comes to unprofitable businesses. On the flip side, the shrinking pool of dividend focused investors have been hunting down dividend paying businesses. Some of these businesses have high yields. Retail and professional investors alike will warn others on Reddit and social media to not reach for yield. Let’s take a moment to challenge that philosophy.
In today’s market, you have ultra low dividend payers (like Apple, Nvidia) or no dividend payment companies representing growth. These companies have taken off during the era of ultra low interest rates. Many of them sit on a significant amount of cash. Instead of increasing their dividend yield, many buyback shares (often at the worst times) for stock based compensation (SBC) or to juice their EPS. Shareholders during the last few decades haven’t put up much of a fuss, because “stocks go up.”
The dividend investor is left with fewer options. If your goal is to live off of dividends and use them as a meaningful source of income, you have to build a portfolio based on a different set of risks. While many (if not most) dividend paying companies are considered low risk, a 2-3% yield portfolio might not fill the income needs of a retiree. Thus, we have to consider yield risk.
Dividend Yield Risk
When assessing my retirement goals and risks, I built my retirement accounts with a barbell approach – 50/50 dividends and growth (I use SCHD and SCHG). My dividend focused portfolio, however, is how I express my immediate goals and philosophy around being a minority business owner. It might be incorrect, so my retirement accounts are a hedge against my views being incorrect.
The dividend portfolio I’ve built is low beta. I know that with my current savings rate and goals, I need to shoot for a 4.6% dividend yield that grows at 4% every year. The current yield for the S&P 500 is 1.35%. The current yield for SCHD (U.S. dividend ETF by Schwab) is 3.44%. As you can see, those won’t help me reach my income goals alone.
My yield risk, through these options, is not that the yield is too high but too low. The risk of exposure from buybacks going to executives or growth story companies is also too high. I looked elsewhere.
High Yield Opportunities
Yield risk comes into play now. High yields are often viewed as a warning sign – this company might not be doing well or might have to cut its dividend. However, this may or may not be true. During 2022, dividend stocks were seen as a safe haven for investors while growth was chopped by interest rate hikes. In 2023, dividend stocks were left behind. Some more than others.
This opened up opportunities for me and other dividend investors. Energy Transfer (NYSE: ET) was yielding well above 10% at one point as they recovered from the Covid-19 pandemic. British American Tobacco has been punished severely for writing down the value of their combustible tobacco portfolio. Tobacco, energy, utilities, pharmaceutical, and consumer stocks could be bought with 4-9% yields. REITs are still beaten down.
While considering dividend yield risk, it’s something that I personally have to take in order to get to the income levels that my portfolio needs to create. Make no mistake – a high yield might very well be a warning sign. That’s why it’s important for dividend focused investors to look at the balance sheets and cash flow statements. We’re looking at the fundamentals, not growth stories and ZIRP fueled hope.
Assessing Dividend Yield Risk – How I Do It
I view investing in publicly traded companies the same as I view my privately held companies – I live and die by the balance sheet and cash flow statement. Just like my owned and operated businesses, I expect my publicly traded businesses to return cash.
My primary focuses are on:
- Debt
- Dividend Payout Ratio
- Cash Flow / Share
- Cash from Operating Activities
- 5 and 10 Year Dividend Growth Rates
From there, if a business looks attractive, I’ll dive further into research (deeper into balance sheets, cash flow statements, and select analysts reports).
We’re fortunate to live in an era where data is readily available. This is a blessing and a curse. By looking at the data, we can assess whether a stock is unjustly unloved, or if it’s on a path of closing up shop. Through a diversified portfolio, I can afford to take risks on higher yield stocks that I believe are the former. I can blend Visa with Philip Morris International.
Dividend yield risk is a personal decision. It’s probably unwise to build a portfolio of 10 stocks with 10% yields. Likewise, a dividend investor that builds a portfolio of low payers might risk not hitting their income goals and be forced to become a share seller instead of a shareholder.
This post is for entertainment purposes only. The author is not a certified financial advisor or professional investor. It’s simply the ramblings of a retail investor and in no way should be considered financial advice. You are encouraged to discuss your financial goals with a CFA.