There was a recent article in the Wall Street Journal saying that GE showed the pitfalls of investing for dividends. It’s something that I’ve long struggled with in talking with clients and prospective clients. The fact that a company has a big dividend doesn’t mean anything. GE had a big dividend, but it paid out more than twice as much in dividends as it has lost in the last five or six years.
GE is a company that really couldn’t afford to pay those dividends. It was paying them in the hopes of not losing some investors because they know that some people just love buying companies that pay a dividend. But you can’t keep spending what you don’t have, and ultimately it made their financial problems worse.
A lot of times the dividend is big just because the stock price is down. The dividend percentage is based on the amount of the dividend as a percentage of the stock price. What does that mean in practical terms?
If the stock price is doing great, the dividend will look bad. When does the dividend look good? When the price of the shares is down. If the price falls by half, the dividend will look twice as big as it did before, but that doesn’t really help you.
Here is an example. Pretend you own a company that is trading at $100 per share and pays a $2/per share annual dividend, so the dividend yield is 2%. If the stock doubles to $200 and pays the same $2/per share dividend, the yield falls to 1%.
If instead of doubling, pretend the stock fell in half from $100 to $50, the dividend would be 4%. Which scenario is actually better? Hint – the one where the stock doubled and looked like it was paying a meager dividend.
So, sure a dividend can be a nice part of your overall investing return, and you can get a couple percent, maybe 1% or 2% per year that can go into your cash flow, or into other investments, or to buy more of the stock or fund. It’s not the reason for investing in something. It should never be the reason for investing in a stock or a stock fund.
Mike Garry, Yardley Wealth Management. We are a fiduciary, fee-only financial planning, and wealth management firm in Newtown, Pennsylvania. If you’d like to talk about this or anything else, please reach out: 267-573-1019, [email protected] or @michaeljgarry
