There’s some key information about high-yield dividend stocks that I wish I’d known decades ago.
It may be something readers already know. But I was surprised when I did a straw poll among friends. Most investors — and some with portfolios running into the hundreds of thousands of pounds — didn’t get it.
Ignoring FTSE 100 or FTSE 250 companies that pay low yields today (or none at all) could mean missing out on a portfolio’s best performers.
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1. High-yield isn’t better than low-yield
Focusing only on picking high-yield dividend stocks could be one way to compromise long term wealth.
That’s not to say UK companies that pay high yields are badly run. It’s just that high-yield dividend stocks aren’t necessarily the automatic wealth generators that many people think.
While 98% of companies on the FTSE 100 pay dividends, there are two that don’t — Ocado, and Rolls-Royce.
Rolls-Royce shareholders have enjoyed a 173% price gain in the last 12 months. The British engineering company suspended its dividend around the pandemic in 2020.
The general feeling among City analysts is that it has been more important for Rolls-Royce to use its spare cash to stabilise its business and return to profit.
The point is that companies with low yields aren’t inherently worse than companies with higher payouts.
In fact, around half of all stocks on the market pay no dividend at all.
2. Yields go up when share prices fall
Anyone reading who knows this already should feel free to skip this bit. But no-one explained this to me for years.
When share prices fall, dividend yields rise. That’s not because the company has suddenly decided to pay higher dividends to investors. It’s just maths.
Dividend yields are calculated as a percentage. So when share prices are lower? The dividend per share is a larger percentage of that lower share price.
Say a company pays shareholders 10p dividends for every share they hold. Today the company trades at 200p per share. That equals a 5% dividend yield.
If the share price fell by half, to 100p per share? The dividend yield would jump to 10%. I still get paid 10p for every share I hold. But the pound value of my total shareholding has just dropped by 50%.
If a company is performing well, its share price will rise. And its dividend yield will fall at the same time.
3. High yields might not last
The thing that has made me the most money in my investing has been to focus on sustainable dividend growth.
Bear in mind that the average dividend yield paid by FTSE 100 companies over the last 25 years was just 3.8%.
Take BAE Systems for example. In the last 20 years, the company has not overspent on paying dividends. Shares worth 200p in 2004 are now worth 6 times more. It has survived, and thrived. And it has improved its dividend per share for decades.
If I’d have been clever and bought 10,000 shares then, I’d have upped my original stake sixfold, while growing my annual dividends from £370 a year (1.8% yield) to £2,810 a year (2.3% yield).
My money would be working much harder.
Admitting what I don’t know can be embarrassing. But it is, more often than not, a good step to becoming wealthier.
