3 dividend shares I’m avoiding in today’s stock market

Stephen Wright thinks some of the most popular FTSE 100 dividend shares are riskier than they look. Which ones are they and what do investors need to know?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Asian man looking concerned while studying paperwork at his desk in an office

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Dividend shares can be a great source of passive income, but investors need to think carefully about which ones to buy. Mistakes in this area can be expensive.

Over the long term, the best results come from buying shares in quality businesses at attractive prices. But not every company fits the bill in this regard.

National Grid

A lot of income investors love National Grid (LSE:NG) shares and it’s easy to see why. The company’s basically a monopoly in an important industry and this is unlikely to change.

Surprisingly, this doesn’t make it a good investment though. Protection from competitors comes at the cost of regulation and this amounts to a significant potential threat. 

Over in the US, billionaire investor Warren Buffett has highlighted the risk of regulators preventing utilities companies from earning a good return. And UK investors would be unwise to ignore this.

This actually means National Grid could find its profits limited by forces beyond its control. That’s not something I look for in a stock to buy, so I’m leaving this one to others.  

Legal & General (LSE:LGEN) shares have an eye-catching dividend yield of 8.7%. But investors should think about why it’s so high – and why the stock’s down 15% since 2019.

One reason is the business is fundamentally risky. Life insurance contracts are long and pricing them involves trying to assess risks that could be decades in the future. 

If things go wrong, the magnitude of the losses can be huge. And it isn’t clear to me that Legal & General has a clear competitive advantage when it comes to pricing policies.

The company has a good record when it comes to dividends and it could certainly turn out well. But I can see a lot of danger that comes with reaching for that big 8.7% yield.

Vodafone

There’s actually quite a lot to like about Vodafone (LSE:VOD) shares at the moment. The stock’s down 48% over the last five years, but there are signs the future could be brighter. 

The company’s biggest problem has been the industry it operates in. Excessive competition in a capital-intensive business has resulted in poor returns for shareholders. 

Vodafone has a plan to turn things around though. This involves merging with Three in the UK to generate meaningful scale and maximise existing markets where it has no advantage.

This could turn out to be a very good strategy. But nothing’s guaranteed and while some might be attracted to a risky turnaround, I prefer less speculative investments. 

Dividend investing

At the end of Indiana Jones and the Last Crusade, the hero tries to identify the Holy Grail from a series of cups. But there’s a catch – the true Grail gives life, a false one takes it away.

It’s the same with dividend stocks. The good ones can provide passive income for decades, but bad ones can prove to be expensive mistakes.

That’s not a reason to avoid buying dividend stocks entirely. But it’s a reason to be selective in working out which ones are worth investing in.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Google office headquarters
Investing Articles

1 reason I like buying S&P 500 shares – and 1 reason I don’t

Will this investor try to improve his potential returns by focusing more on S&P 500 shares instead of British ones?…

Read more »

Young woman holding up three fingers
Investing Articles

3 SIPP mistakes to avoid

Our writer explains a trio of potentially costly errors he tries to avoid making when investing his SIPP, on an…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

Here’s how (and why) I’d start buying shares with £25 a week

Our writer uses his investment experience and current approach to explain how he would start buying shares on a limited…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

Here’s my 5-step approach to earning passive income of £500 a month

Christopher Ruane explains the handful of steps he uses to target hundreds of pounds in passive income each month.

Read more »

Investing Articles

2 UK shares I’ve been buying this week

From a value perspective, UK shares look attractive. But two in particular have been attracting Stephen Wright’s attention over the…

Read more »

Investing Articles

A lifelong second income for just £10 a week? Here’s how!

With a simple, structured approach to buying blue-chip dividend shares at attractive prices, our writer's building a second income for…

Read more »

Investing Articles

Here’s how I’d use a £20k Stocks and Shares ISA to help build generational wealth

Discover how our writer would aim to turn a £20k Stocks and Shares ISA into a sizeable nest egg by…

Read more »

Investing Articles

Billionaire Warren Buffett just bought shares of Domino’s Pizza. Should I grab a slice?

Our writer takes a look at a few reasons why Domino's Pizza stock might have appealed to Warren Buffett's Berkshire…

Read more »