If you’re my Facebook friend or tune-in to my weekly radio show, you know I believe that investing should be boring. As I like to say, “If you want excitement, try hang gliding. If you want to gamble with your money, go to Vegas.” So allow me to indulge for a few minutes in some wise (but not too exciting) financial advice. That said, I don’t have a “hot” stock tip, but I do have a better tip about stock yields.
These are the days of historically low interest rates, and many investors have looked to stock dividends for a better yield on their money. A dividend is simply extra money a corporation has in its coffers. It returns some of that money in the form of dividends to its stock holders. For example, if XYZ Corporation is valued at $100 per share, and the company issues a $2 dividend, the initial dividend yield is 2%. Pretty simple. Of course, nothing in my business of financial planning is ever simple, especially when investors get greedy and search for stocks with the highest dividend yield.
Let’s say XYZ’s stock hits a bump in the road and drops from $100 to $50 per share; however, they still decide to pay their $2 per share dividend. The dividend yield now goes up to 4% because $2 dollars is 4% of the $50 share price. That’s just basic math, not magic. But the real story is that I just lost half of my investment! But the greedy investor thinks he’s getting a deal because of the higher yield. In reality, though, he’s getting the same $2 per share when the stock was at a higher price.
Now let’s look at some real world examples of a few stocks with current high yields. AT&T has a dividend yield of 5.1%. That sounds great: a gigantic, profitable company with a high yield. But when we take a look under the hood, AT&T’s stock has been flat over the past twelve months while the S&P 500 index gained 13.66%. The highest yielding stock with a whopping 11.5% yield is Transocean, an oil drilling company which (by the way) lost over 51% in the last twelve months. All I can say is “Ouch!”
Many investors are under the illusion that owning a high yield stock comes with low risk. Unfortunately, in the real world, such beasts are extremely rare, and as any professor of finance might say, “There is no free lunch in the world of investments.” In fact, only half of the top-yielding stocks are paying higher dividends than they paid a few years ago. Others are now sporting rich yields in large part because their share prices have declined. That’s further justification that yield alone is not a good reason to buy any stock.