3 High Yield Dividend Investing Tips That Could Earn You Thousands
Income investors are often older and preserving capital is their top priority. When investing, avoiding pitfalls is a key way to make money. A 40% loss on one stock can wipe out a lot of 10% gains on others. Value investors often speak of “value traps,” and this concept is relevant to income investors. Here are some tips that can help you spot red flags and avoid landmines.
1. Understand the competition
If a stock’s dividend yield is higher than its peers, it is often a danger sign that the dividend will be reduced in the future. This usually happens when the business is in trouble and the business does not have the income to cover it. We saw it in the spring of 2020 when Wells fargo yielded more than 7% while its competitors yielded around 3 to 4%. Wells ultimately cut its dividend by almost half. Whenever a high performance catches your eye, it’s worth taking a quick look at the company’s competitors and seeing if the performance is irrelevant. If so, compare the annual dividend to earnings per share. If the dividend is greater than earnings per share, that’s a bad sign. It’s a trick that might not net you much, but a dime saved is a dime earned.
Take a look at the chart below, which compares Wells’ dividend yield to that of JP Morgan, Citigroup, and Bank of AmericaAt the start of 2020, Wells’ return was too good to be true, and the dividend was cut in half.
WFC Dividend Yield Data by YCharts
2. Understanding the catalysts
The Federal Reserve has supported the economy by purchasing Mortgage Backed Securities (MBS) as part of its response to COVID-19. Fed purchases provide artificial support to the MBS market and that support will eventually disappear. In his prepared remarks to Congress, Fed Chairman Jerome Powell said the end of MBS purchases was “a way to go,” but looming on the horizon.
In 2013, the Fed warned against cutting MBS purchases and investors threw the asset class overboard. The price difference of MBS versus treasury bills has dropped dramatically, and with it, stock prices of Annaly Capital and AGNC investment. Eventually, the Fed will start to cut back on its purchases of MBS, and it will announce this well in advance. At this point, the party draws to a close. Don’t stay too late.
3. Understanding the macroeconomic environment
Not all actions work over the entire business cycle. In fact, most don’t. Financials perform better when the economy is recovering from a recession, and very poorly at the end of the economic cycle. The cyclical, consumer discretionary and defensive cycle are all different. If the economy is strong, now is the time for consumer discretionary stocks and cyclicals. If the economy is bad, defenses are the way to go.
Even real estate investment trusts (REITs) can vary; a net rental company like Real estate income (NYSE: O) will work differently from a mall REIT like Simon Real Estate Group. Master Energy Limited Partnerships (MLPs) will often react to oil prices.
Trying to enter and exit sectors based on your personal economic forecasts is difficult to do, but periodically checking your portfolio against the current state of the economy can pay (or avoid loss of) dividends. .
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.