I wrote about the reach for yield a few weeks ago. Here’s the dividend stock edition for yield chasing.
Alliance Bernstein has a graph showing what investors are getting from dividend ETFs versus a growth stock counterparts.
Today, investors are currently paying growth stock prices for dividend stocks. That might be okay if dividend stocks got growth-stock-like earnings growth. But that’s rarely the case.
The reason most dividend stocks pay a dividend is that their earnings growth is limited. If they could reinvest more earnings to grow at a higher rate, they would. But they can’t. So they don’t. So they choose to pass a portion of earnings on to shareholders.
Alliance Bernstein also points out the above average payout ratio (the portion of earnings paid out as dividends) is at 89%, compared to a 74% historical average.
This could be due to any combination of falling earnings, higher costs, or dividend increases. In any case, it leaves less available money for the company to reinvest for earnings growth.
It also leaves less room for error. If earnings take a big hit or see an extended decline, dividends might need to be cut. Nobody who owns a dividend stock for its income wants to see that.
This doesn’t mean all dividend stocks are expensive and at risk. My point is to be aware of what you’re paying for. Price matters when considering yield. So does the ability to continue paying that yield.
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