From time to time, opportunities come along to buy shares in companies that appear set to pay out dividends of 10%, 20% or even more. Novices often get very excited by this. After all, those are better rates than the interest on deposit accounts. And why hope for unreliable capital gains in the shares of companies paying low dividends, when you can reliably get paid the same amount as cash in hand?
The argument would be true IF the payout were reliable. In practice, it seldom is. The percentage a company pays out - the dividend yield - rises automatically if the dividend is maintained while the share price falls. But in those circumstances, a yield that rises from, say, 2% to 10% corresponds to a share price that has fallen 80%. That is invariably a warning that a company is in grave trouble. If you invest in such situations simply for the dividend, you are most likely risking significant loss of capital.
Example
Suppose you invest for a 10% yield and the share price then halves over a year. Your total return from capital gains/losses and dividends will be
100% - 50% + 10% = 60%, i.e. 0.6 of your original 100%, or a 40% loss.
In addition, companies in that much trouble often cut or eliminate the dividend to conserve cash. If you fail to get the payout you had banked on, you will have lost half your money.
Bear in mind that above-average dividends are usually a pointer to below-average growth. Companies tend to pay out that much because they cannot find ways to reinvest cash more profitably. So if you opt for income, you usually have to sacrifice some growth. That's fine, provided
Quote
"If your stocks are down 25% in value, isn't it rather absurd to say you're alright because you're getting a 4% yield?"Book offers!
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