Dividend stocks are popular with investors due to their regular cash flow and perceived lower risk. But are they a smart option?
What Are They, and Why Are They So Popular?
Dividend stocks pay a portion of their profits and distribute it directly to investors quarterly or monthly. Not all stocks pay dividends, and that’s one of the critiques of this approach. But for stocks that do, they may pay, for example, a 5% dividend yield, which means that if the stock is trading at $100, over the year, you can reasonably expect, all else being equal, that you will receive a payment of $5.
Why Don’t We Recommend Focusing on Dividend Stocks?
Reason #1: Stocks are stocks whether they pay dividends or not
Dividend stocks are still stocks. They are going to be responsive to what is going on in the broader economy and of course, specifically, what’s going on with those companies. So you don’t necessarily remove the risk of stock market investing. In addition, dividend payments are at the company’s discretion. You can own a stock paying that 5% dividend yield, but if the company hits a rough patch, it can eliminate or cut the dividend. This leaves you with a decline in cash flow. Recent examples of companies that cut their dividends since the pandemic include Anheuser-Busch, BP, Capital One, MGM, and Wells Fargo.
Reason #2: Many Companies Don’t Pay Dividends
50 years ago a significant portion of stocks paid dividends. That has changed to the point where currently, a relatively small fraction of companies pay dividends. focusing only on dividend stocks leaves you less diversified than is recommended. Examples of companies that don’t pay dividends include Amazon, Google, Berkshire Hathaway, and Facebook.
Reason #3: Value Investing Offers Diversity
Value investing is the concept of buying stocks that are trading at low prices relative to earnings or the book value of the company compared to the broader market. This approach also tends to own the dividend stocks as part of it automatically. So it doesn’t only own those companies, but they tend to frequently fall in the value bucket. So that’s a way to have these companies represented in a stock allocation but not be exclusively focused on those companies.
Examples of value stocks include Shell, Exxon, Pfizer, Johnson & Johnson, Verizon IBM, and Coors.
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