Last Updated: Saturday, July 15, 2017

Why you should avoid high dividend paying companies

"High dividend yield is an indication of lack of opportunities"

What is Dividend yield?

Dividend yield is a financial ratio indicating how much dividend is paid to it's shareholders each year in relation to the price of each share of the company. The dividend yield is expressed as a percentage and can be calculated by dividing the money value of dividends paid in a given year per share of a company held, by the market value of a share. 

Image: Avoid high dividend paying companies invest in growth stocks,

Why companies pay high dividend?
The main reason why companies pay high dividends is because management can not find better growth opportunities within its own company to invest its undistributed profits. As a result, management returns excess profits to shareholders in the form of dividends or share buyback. If a company pays a dividend equivalent to a 5% return, management is basically telling investors that they can not find better investments in the company that are more than 5%. Their growth will largely be determined by exogenous variables, namely the state of the economy.

To understand it in a better way let's consider following two cases;
1. Imagine that you are the CEO of a high-growth company like Tesla Motors (TSLA), the manufacturer of high performance electric cars. Do you think Elon Musk, the current CEO will start paying a dividend with his profits instead of resorting to research and development for new models with a longer battery life? Of course not! It would be absolutely pathetic if Elon Musk could not beat a 5% return on his capital. Tesla Motors is up 500% since its opening in mid 2010 and now Elon is a billionaire.
2. On the other hand, telecommunications company like AT&T (T) which has the largest wireless network in USA. According to Pew Research, mobile penetration is over 85% in USA , and AT & T has the largest subscriber base in the industry. Since AT&T is like a utility the generation of cash flow is high but accelerated growth prospect is low. Due to strong cash flow and the absence of better investment alternatives, AT&T pays a huge dividend of $ 1.80 per share, which equates to a 5% dividend yield with the stock To $ 35.  AT & T has increased merely by 50% since the low of 2009 while S&P 500 increase by 140%.

I now hope you understand why high dividend yield should not be a single stock selection parameter.

Keywords; Dividend yield, high dividend stocks, growth stocks, dividend paying companies, avoid high dividend

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