The Hidden Dangers of High-Yielding Dividend Stocks
My journey into the world of real estate investment trusts (REITs) began with Annaly Capital Management (NYSE: NLY), a stock that promised an attractive dividend yield in the high single digits. I thought I had stumbled upon a goldmine, but little did I know that this investment would teach me a valuable lesson.
The Lure of High Dividend Yields
At first, I was drawn to Annaly’s high dividend yield, thinking it would provide a steady income stream. However, my experience with the REIT was a sobering one. Despite its alluring yield, the stock price eroded over time, and the company cut its dividend payment several times. I realized that investing in a stock solely because of its dividend yield can be a costly mistake.
The Importance of Sustainability
I’ve learned that a company’s ability to sustain its dividend is crucial. Three key factors drive a company’s ability to maintain its dividend over the long term:
- Stable and growing earnings: A company must operate in an industry where it can produce relatively steady earnings that can increase over time.
- An adequate cash-flow cushion: A reasonable dividend payout ratio (75% or less, depending on the industry) provides a much-needed cushion to weather unexpected headwinds.
- A strong balance sheet: A solid financial foundation, marked by an investment-grade credit rating and a conservative leverage ratio, is essential.
The Power of Dividend Growth
Data shows a strong correlation between dividend growth and outperformance. Companies that grow their dividends have historically delivered higher total returns, while those that cut their dividends have produced negative returns.
Finding the Sweet Spot
While a high dividend yield can be attractive, it’s essential to find companies with higher-yielding dividends that can consistently grow their payouts. These companies tend to have a dividend payout ratio around 40%, which allows them to maintain a sustainable income stream.
A Costly Lesson Learned
Investing in Annaly Capital Management taught me that buying a stock for its yield alone can be costly in the long run. Instead, I’ve learned to focus on companies with higher-yielding dividends that can consistently grow their payouts. These companies have historically produced the highest total returns over the long term.
Before You Invest…
Consider the importance of sustainability and dividend growth before investing in any stock. Remember, a high dividend yield is not always a guarantee of success.
Leave a Reply