Dividend investing is based on the idea that by paying a dividend, a company has established itself as relatively stable financially, and that therefore it is worthy for investment consideration. However, dividend investing can be tricky, and it is easy to make mistakes. Making mistakes in dividend stocks can be very costly, as such mistakes often come from the standpoint of complacency. Here are three common mistakes to avoid.
1. Chasing yield
This is probably the biggest mistake that dividend investors make. Investors will often judge a company’s value or upside potential by its dividend yield, and they will reason that a stock with a high yield must be cheap. But there are two problems with stocks that have high dividend yields. The first is that they often have very slow dividend growth rates.
So while the dividend may be high today, it could remain the same or rise only slightly in the long term, and this will restrict your gains. On the other hand, a company that is growing its dividend but which pays a low dividend will likely outperform in the long run because it is using the capital it is not paying out in the form of a dividend to grow its business. Thus, if you buy a dividend growth stock now, in 10 years, the dividend could be very large relative to your initial investment, and this is what you want when you are investing in dividend companies.
The second issue is that a high dividend could be in trouble, meaning that the company could be forced to cut it. In this low-yield environment, investors should view high yields with skepticism, and they need to make sure that they understand why the market isn’t willing to bid up a high-yielding stock. While you may spot an overlooked gem, this is unlikely, considering that we are in a stock bull market and that investors are generally viewing the glass as half full. Thus, a high yield can often be a red flag, and it might be best to stay away.