Buying a Stock for Its Dividend Can Sometimes Backfire
Often, you will hear pundits on TV recommending a stock because of its juicy dividend yield (sometimes cited when yield is more than 3%). One sector that has been beaten down recently is the financial sector, due to the subprime mortgage crisis. Because of this issue, the dividend yield on many of these stocks look relatively attractive.
However, the dividend yield metric (annual dividend / current stock price) is generally a backward looking measure and does not reflect actions that a company may take to shore up its finances in a pinch. Because of major writedowns on mortgage investments, many financial institutions are seeking capital to improve their balance sheets. One way to increase capital is to pay out less to shareholders in the way of dividends.
One firm that looks attractive on a dividend yield measure is Citigroup (C). Looking at today's (12/27/07) closing stock price on Yahoo! Finance (29.56) and with a stated annual dividend of 2.16, the dividend yield appears to be a healthy 7.30%. However, in reading today's headlines, there is a story from MarketWatch.com that explains that a research analyst from Goldman Sachs expects Citigroup to cut its dividend by 40% because of an expected $18.7 billion dollar writedown.
Often, a dividend yield will become high because of recent weakness in a stock. Since the market participants generally try to look forward to the future of a company, price weakness in a stock may be a precursor of trouble ahead or a response to a bit of bad news already out. If a stock has been weak, you may end up trying to "catch a falling knife", which is Wall Street speak for trying to catch the bottom on a rapidly declining stock.
When the subprime crisis started to unfold, many of the mortgage real estate investment trusts (REITs) declined in value and sported yields in excess of 15%. However, it would have been a mistake to buy these, as the share prices continued to fall in response to massive losses and suspension of their dividends.
Right now, no one knows when the bleeding will stop on subprime investments gone sour or if there will be any contagion into other types of loan-based investments such as auto loans or credit card balances. Therefore, it may be wise to wait for some stability before putting a large portion of your portfolio on the line in some of these firms.
If you are able to research the stock and find that the dividend is not in jeopardy, then buying a high dividend yield stock may pay off handsomely. However, the important thing is to do your own homework and not to blindly trust that everything will be the same going forward as it has been in the recent past.
However, the dividend yield metric (annual dividend / current stock price) is generally a backward looking measure and does not reflect actions that a company may take to shore up its finances in a pinch. Because of major writedowns on mortgage investments, many financial institutions are seeking capital to improve their balance sheets. One way to increase capital is to pay out less to shareholders in the way of dividends.
One firm that looks attractive on a dividend yield measure is Citigroup (C). Looking at today's (12/27/07) closing stock price on Yahoo! Finance (29.56) and with a stated annual dividend of 2.16, the dividend yield appears to be a healthy 7.30%. However, in reading today's headlines, there is a story from MarketWatch.com that explains that a research analyst from Goldman Sachs expects Citigroup to cut its dividend by 40% because of an expected $18.7 billion dollar writedown.
Often, a dividend yield will become high because of recent weakness in a stock. Since the market participants generally try to look forward to the future of a company, price weakness in a stock may be a precursor of trouble ahead or a response to a bit of bad news already out. If a stock has been weak, you may end up trying to "catch a falling knife", which is Wall Street speak for trying to catch the bottom on a rapidly declining stock.
When the subprime crisis started to unfold, many of the mortgage real estate investment trusts (REITs) declined in value and sported yields in excess of 15%. However, it would have been a mistake to buy these, as the share prices continued to fall in response to massive losses and suspension of their dividends.
Right now, no one knows when the bleeding will stop on subprime investments gone sour or if there will be any contagion into other types of loan-based investments such as auto loans or credit card balances. Therefore, it may be wise to wait for some stability before putting a large portion of your portfolio on the line in some of these firms.
If you are able to research the stock and find that the dividend is not in jeopardy, then buying a high dividend yield stock may pay off handsomely. However, the important thing is to do your own homework and not to blindly trust that everything will be the same going forward as it has been in the recent past.
Powered by ScribeFire.
Comments