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Why high dividend yields aren't everything?

Updated: Apr 9

The idea of earning passive income through dividends while you sleep is certainly attractive. This is probably a reason many investors believe that high-dividend stocks are the key to achieving financial freedom.


Let me share with you a lesser-known truth within the world of fund management. Simply including the word "dividend" in a fund's name can boost sales, even if the fund's actual investment strategy is not centred around dividend stocks.


Rethinking dividend-driven strategies


While it is tempting to focus solely on dividend yield when selecting investments, this approach can be limiting and may not offer a comprehensive view of the investment.


There are also five other reasons why relying exclusively on dividend yield can be problematic:


1. Misleading High Yields: A high yield does not necessarily suggest a sound investment. It could be due to a declining stock price, indicating that the company lacks the earnings to maintain the dividend.


2. Neglecting Other Factors: Dividend yield is just one consideration. Other crucial factors include the company's financial health and growth prospects.


3. Risk of Dividend Cuts: Companies may reduce dividends for several reasons, like financial troubles or the need to reinvest in the business. Overlooking stability and sustainability when focusing just on the dividend yield can lead to unexpected income drops.


4. Limited Diversification: Overemphasizing high-yield stocks can concentrate a portfolio in specific industries, increasing risk if those industries face challenges.


5. Short-Term Focus: Investors who merely prioritize dividend yield may sacrifice long-term growth potential, missing opportunities for wealth accumulation and portfolio growth over time.


So, instead of fixating on stocks that promise the highest dividend yields, it is better to consider the total shareholder returns.


What is total shareholder return?


Total shareholder return is the absolute measure of the overall gains or losses an investor experiences, accounting for both stock price appreciation and dividends received.

Total Shareholder Returns equals Stock Price Appreciation plus Dividends. Look at the Total Shareholder Returns instead of the Dividends only.


Prioritizing total shareholder return over dividend yield alone provides a more comprehensive view for both companies and investors.


Companies often decide between reinvesting profits in areas like research, acquisitions, or growth initiatives versus distributing dividends. By emphasizing total shareholder return, it encourages companies to convey their strategic intentions to investors and make capital allocation decisions that align with their long-term goals. This strengthens the link between corporate strategy and investor expectations.


For instance, high-growth companies like Meta Platforms and Alphabet prioritize reinvestment over dividends. They do not pay dividends but still generate value for shareholders through stock price appreciation.


Another key point to note is that total shareholder return fosters an emphasis on long-term value creation.


So, if you ever chance upon a company that pays an attractive dividend yield, start to think in terms of the total shareholder return instead. This is to prevent you from falling into an investment trap.


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