The concept of yield, which is the cash dividends paid over the past four quarters divided by the share price, is an important factor for many investors. It is often compared with the price/earnings ratio as a key metric for evaluating stocks. Some of the top blue chip companies with high yields include Verizon, Ford Motor, and United Parcel Service, offering more immediate gratification than the average U.S. stock. However, pass-through entities like business lenders, pipeline partnerships, and real estate investment trusts are excluded from this list.
While dividends were previously considered the primary reason to own a stock, the dividend discount model, which values a stock based on its future dividends, is becoming less relevant as dividends are becoming less common. In fact, of nearly 2,000 U.S. companies with market values of at least $1 billion, 43% do not pay any dividends. Reasons for this range from financial weakness to reinvesting profits back into the business to distributing profits through share buybacks.
Although generous dividends can be beneficial for investors looking to live off their portfolios, they also come with downsides. One downside is the trade-off between a high yield and a high growth rate, as companies distributing large quarterly checks are less likely to see rapid earnings per share growth. Additionally, a high dividend may not always be sustainable, as illustrated by General Motors, which went bankrupt after consistently paying out substantial dividends. Investors looking for dividends should also be cautious of companies with payout rates near or above 100%.
Furthermore, companies in declining industries, such as cigarette manufacturers or fossil fuel companies, may see their dividends decline over time. For example, Altria Group, the maker of Marlboros, is facing a decrease in cigarette volume as customers decrease. Similarly, oil companies with high dividend yields may struggle as the demand for fossil fuels decreases. The list of big payers also includes companies that distribute cash through share buybacks, which can be a more tax-efficient approach compared to quarterly dividend payments.
Overall, understanding the implications of high dividends, including their potential unsustainability and association with declining industries, is crucial for investors seeking to maximize their portfolio returns. Considering the trade-offs between yield and growth, as well as the prevalence of companies not paying dividends, can help investors make informed decisions on where to allocate their capital in the stock market.
