Dividends, those seemingly tiny cash payouts to company shareholders, have been the lifeblood of stock market returns over the past 80 years.
A look at the historical picture between 1930 and 2010 shows that dividends accounted for 44% of the market's returns in that time. In the lackluster stock markets of the 1970s, dividends provided 71% of returns. That's an astounding number, no matter how it is crunched.
As you can see in this chart, dividend-paying companies have outperformed the overall market by 155% between 1972 and 2012:
Source: Dreyfus Corp.
While 2013 was a banner year for dividends, the positive trend is slated to continue throughout 2014. Research firm Markit forecasts that S&P 500 dividends are expected to increase by 8.9%, to $352 billion.
Regular readers of Amy Calistri's Daily Paycheck advisory understand the importance of dividends, know which stocks the smart money is buying -- and even understand the occasional dangers of high-yielding stocks. Let me explain.
High dividends do not always mean the stock is a good investment. Remember, dividend yields are the current yearly dividend payment divided by the stock price. Therefore, yield is only what the investor can expect to earn if he buys at the present price. The dividend yield's not fixed in stone for the year. The dividend can remain exactly the same, yet share prices can drop, which results in the yield increasing.
As you can see, falling prices are a major risk with high-yielding stocks. A falling stock price counteracts a high dividend yield, potentially creating an overall losing investment despite the high yields. In addition, falling stock prices and rising yields sometimes result in a company slashing dividend payments, which can trigger a downward price spiral in an already weakened stock.
Since payment of dividends is a decision made by the board of directors of the company, dividends are sometimes hiked in a last-ditch effort to attract investors and divert them from the company's internal issues.
Dividends can also be cut during difficult economic times. For example, by the end of 2009, 804 companies had slashed their dividends in an effort to raise balance sheet cash.
In addition, dividends are cut to pay for acquisitions and other cash needs. This means that a reduced dividend is not necessarily a sign of trouble inside the company.
While dividends remain the best way to boost income from stock investments, it's critical to look behind the dividend at the company itself prior to investing. Many investors get caught up in the high yield itself -- and therefore, they fail to examine the reasons and likely sustainability of the high yield.
Let's take a brief look at two of the highest-yielding stocks on the market today to determine if their high yields make investing sense going forward. (I deliberately left out business development companies (BDCs), real estate investment trusts (REITs) and corporations with a market cap of under $500 million; this screen prevents outliers from slipping into the mix and keeps tiny, high-risk firms from being considered.)
|1. Windstream Holdings (Nasdaq: WIN)|
| A $4.5 billion technology and communication company, Windstream posted revenue of $6.2 billion and gross profit of $3.3 billion in its most recent fiscal year. The company has $73.4 million in cash, and its share price is down 21% over the past 52 weeks.
Paying a forward annual dividend yield of 12.7%, it is the highest-yielding stock on my screener. The company has a high debt-to-equity ratio of 10.35, not to mention a quick ratio of 0.71, which indicates Windstream will likely have issues paying short-term debt.
|2. Ship Finance International (NYSE: SFL)|
| This $1.6 billion company is involved in the ownership of oceangoing vessels and other offshore assets. With revenue of $320 million and $126 million in cash, a gross profit of just under $225 million and a quick ratio of 0.53 suggest the firm may also have issues with short-term debt repayment.
SFL yields 9.3%, making the company the second-highest yielder on my list, but earnings are expected to plunge from $2.26 to $1.06 a share this year, representing a 53% decline.
Risks to Consider: Dividend investing should continue to provide excellent returns into the near-term future. However, it's important to keep in mind that high-yielding stocks can often have weak fundamentals or performance that can counteract the benefits of the high yields. In addition, high yields alone can signal deep-seated issues within the company. Always investigate before you invest, and be sure to use stop-loss orders and diversify properly.
Action to Take --> Windstream and Ship Finance both have been put on my temporary ignore list due to their questionable fundamental metrics. They are both classic examples of risky stocks with high yields. If you own shares, I would suggest selling and looking for companies that have stronger fundamental support of their dividend yields.