Why Choose Low Yield over High Yield Stocks?

It is not unusual after I publish a list of stocks to get a comment or two asking why those stocks and not these stocks. Often the real thrust of the question is why buy those low yield stocks when you can buy these high yield stocks. The answer involves risk and its management.

When I started investing in dividend stocks for income, I did as most new income investors – I chased yield. To make things worse, I had success early on. At one time I had a portfolio consisting of Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs) and high yield, high risk stocks. The portfolio’s yield was consistently in the low to mid-teens. I remember once being disappointed in buying a stock that only yielded 8%.

As I continued to read and learn about investing in dividend stocks, it became apparent that I was doing it the wrong way. I started to unwind my high-yield strategy and move into more traditional dividend stocks. However, the high-yield strategy was still experiencing some success so I did not move as fast as I should and ultimately suffered some unnecessary losses.

My portfolio still carries some remnants of my high yield investing days with stocks such as:

• Integrys Energy Group Inc. (TEG) – Yield: 7.62% – Div. Growth: 1.5%
• National Retail Properties (NNN) – Yield: 6.75% – Div. Growth: 1.4%
• Realty Income Corp. (O) – Yield: 6.33% – Div. Growth: 2.1%
• Health Care Property Investors, Inc. (HCP) – Yield: 6.12% – Div. Growth: 1.1%

None of the above stocks are currently on my buy list, mainly due to their underlying fundamentals. I suspect over time they will work their way out of my portfolio.

The focus of my income portfolio is now on blue chip dividend stocks with a long record of growing their dividends. Examples of companies I now follow include:

• Johnson & Johnson (JNJ) – Yield: 3.18% – Div. Growth: 7.5% – Analysis
• The Coca-Cola Company (KO) – Yield: 3.05% – Div. Growth: 7.9% – Analysis
• Abbott Laboratories (ABT) – Yield: 3.48% – Div. Growth: 8.4% – Analysis
• Emerson Electric Co. (EMR) – Yield: 3.21% – Div. Growth: 6.4% – Analysis

You will notice the yields on each of these stocks are much lower than those in the first group, but they provide a much stronger dividend growth rate. Over time their yield on cost will grow much faster than the first group, thus have a good chance of producing more income.

That is not to say I have completely walked away from high yield investments. Like salt and pepper, I use them to add a little flavor to my income portfolio, but in limited and controlled portions. Here are some high yield securities that I hold that have performed well for me:

• Alpine Total Dynamic Dividend Fund (AOD) – Yield: 15.74%
• Eaton Vance Tax Advantaged Global Dividend Fund (ETO) – Yield: 7.33%
• CenturyLink Inc. (CTL) – Yield: 8.86%

AOD and ETO are ETFs that pay a steady monthly dividend, but each has cut the dividend over the last 12 months. CTL’s dividend has been flat at $0.70/share for 5 straight quarters. If you invest in such securities, you should understand the inherent risk and limit your exposure. I likely will always have a place in my income portfolio for riskier securities, but as I grow older the place will grow smaller.

Full Disclosure: Long ABT, AOD, CTL, EMR, ETO, HCP, JNJ, KO, NNN, O, TEG. See a list of all my income holdings here.

Comments

[Senan:]

I'm at the beginning of your journey, although I will also purchase some smaller growth shares etc. I've started with Exelon (EXC). I'll read your posts with interest, cheers.

Sep 24 03:41 AM

[dcxman:]

If you have held AOD for a long time dividends haven't kept up with share loss.

Sep 24 05:46 AM

[tipalia:]

The eternal debate which in my view (I share the author s view) is not one which yielding stocks to buy. Buy JNJ , EMR , ABT when they become value stocks . A good example of that is ABT right now . If you don t buy it now you will never buy it for all the reasons you want.
Buy the stocks on dividends4life s list when they are at a deep discount . You may have to wait a long time but the reward is huge. I always wanted to buy ABT and now that s what I am doing. I did the same thing with JNJ and now I am patiently waiting for EMR to come down. TY dividends4life for your help ,

Sep 24 08:38 AM

[tipalia:]

One final note I wished you had more pure global companies on your list such as DEO for example . It would give us some kind of protection against the weak, and maybe weaker to be , US $ .

Sep 24 08:45 AM

[Michael D.:]

The biggest opportunity missed was EMR in the spring. Good company.

Sep 24 08:48 AM

[David Van K...:]

On dividends not keeping up with share loss: Know your goals. While no one would choose to have a loss in total return (that is, capital gain/loss + dividends), once you own a dividend stock, its real value to you is its ability to keep sending out ever-increasing dividend checks. That characteristic may or may not correspond with its current market price, which is less important, because your intent is not to sell it at a profit, it is to keep receiving those dividends.

Over very long periods of time, hopefully the share price will recover, but even if it does not, you have still achieved your goal of ever-increasing dividends. (After all, with an annuity, for example, you forfeit ALL of your capital forever for the right to receive an income stream...and that stream does not increase over time, as it does with dividend stocks.)

Sep 24 09:03 AM

[YoYoMama:]

The market is far too volatile right now for me to consider holding any stock - dividend or otherwise - long enough to risk depreciation.

I will not feel comfortable holding long-term until the next secular bull, which we will not experience for at least another 5 to 7 years, if historical trends hold.

Therefore, if I want to hold a high dividend payer in my portfolio for any amount of time - weeks, or months - reap the dividend, then sell it at a profit when the stock or market takes a down trend, I don't feel I have anything to apologize for. Indeed, I have been able to increase one portfolio almost 90% since March lows using this strategy.

It's only when you marry your position that you risk what the author is talking about. But if you are expecting capital appreciation, you should also understand that you can better obtain this in a secular bull.

But that's not the market we're in. So if you are expecting any capital appreciation in this secular bear, you best watch your holdings very carefully, be prepared to sell, and, in my opinion, shoot for a higher dividend yield than 3%.

Sep 24 10:49 AM

[Vaun:]

I remember ETO having an obnoxiously high fee buried in the fine print... (over 2%) and that its high yield is accomplished through various strategies such as dividend harvesting. (Rotating in and out of stocks before their dividend dates... but long enough in advance to have favorable dividend treatment) Funny, according to the Eaton Vance website the "Online prospectus [is] currently unavailable"

Sep 24 11:04 AM

[mbkelly75:]

A lot depends on your time-frame. Over 20-25 years, 3.1% to 3.8% (The Golden Ratio of Dividends) even without re-investment of dividends can be enough to give huge returns. Over the 25 years between 1983 and 2008 - NUE returned an annual average of 100.25% and while MMM only returned 17.88% annually during that time - it still beat the S&Ps 16.36% return over that time period. There is nothing wrong with high-dividend returns but you do not need them over the longer term. Check the article at Money Magazine about this.

Sep 24 11:07 AM

[RLLH:]

One minor correction, CTL is the symbol for Centurytel Inc on the NYSE.

Sep 24 11:14 AM

[TheHague:]

I own CMO right now. Primarily because of its payout! Its share price appreciation has been good to this point as well. 16% appreciation for its share price plus a .56 dividend this coming quarter! However, I can see what this type of REIT is and that is a short play. I prefer JNJ, XOM, PG, etc. However, I agree with YoYoMama in that one has to be very careful in this market. It is unstable at best and the threat of a severe drop similar to March 09 and Nov 08 lingers. Watch your own back! Depend on your own wits and strategy! When the Pooh hits the fan you will be the only one around and then what happens? You get left with worthless stocks and an empty promise of a dividend that may or may not come! The only marriage I want is to my Bride of 32 years!

Thank you for your article. I read every post. You always give me things to think about and a solid perspective!

Sep 24 11:20 AM

[whisperonth...:]

Three years ago, I was comfortable in my retirement outlook. Two years ago, I assumed it would be a small bubble and I could ride it out as I have before. One year ago, I was looking at my "blue chip" investments and knew they were not going to make it this time, I had lost 65% of my retirement package and I would have to work until I was 80 or older to make that money back. Thanks to banks going under, and the ETFs that took a hit because they had invested in those also, I decided I was taking control of my own investment package. Since then, I've made most of my money back, listening to a different drummer. That drummer is the one that told me I really don't want to work until I'm 80, and that I'm not above a bit of risk.

I may be broke before I'm 80, but currently it doesn't appear to be the case. Onward, drummer.

Sep 24 11:22 AM

[Juliet:]

AOD's monthly distributions may include return of capital.

This useful CEF site separately states "income only yield" from the quoted "distribution yield" --the difference between the two numbers can be the degree to which the CEF is cannibalizing itself to generate so-called "yield":
www.closed-endfunds.co...

Sep 24 01:18 PM

[Dotcom:]

I'm in tune with Tipalia (above):

Buy quality dividend stocks at a good entry point and
it's time to be looking at dividend stocks of companies that do business globally.

I'll take all the information I can get on when to buy e.g. ABT is now at a good entry point.

Dividend Paying stocks that have a global footprint that I'm aware of - PM, MO, KO, MCD, BP. I don't know if now is the time to buy any of these due to entry point/price.

I would also be interested in hearing of other other global dividend paying stocks.

Sep 24 05:27 PM

[Joe Eqcome:]

The underlying assumption of your thesis is that lower yielding stocks with greater dividend growth rates would sell at a higher future stock valuation. This share price appreciation would offset the initially higher cash dividends of companies with higher dividend growing at a slower rate. This is a reasonable assumption for long-term investors for the examples you've provided.

In your example, both for a 5 and 10 year holding period, assuming the stock’s value at the end of the holding period is based on the last year’s dividend divided by the now current yield, investors are better off owning low yielding, higher growth dividend stocks. They have higher IRR's. (Interestingly, this is also holds true if the yield proportionately declines 50% or increase 100%.)

If however, the yields of lower, higher yielding stocks do not change proportionately, due to a specific set of economic or financial circumstances, it is possible higher yield, lower growth stocks could do better.

This would be the case if the higher yielding lower growing stocks were selling at a greater discount to their intrinsic value than the lower yielding stocks due to investors’ risk assessment.

If that discount for the higher yielding stocks at some future point were to narrow as risk assessment eased, it would impact their yield multiple favorably relative to the low yield, high growth stocks.

The other case where high yield, low growth stocks may do better is in very short holding periods. This might be the case in the trading of high yielding stocks in the face of a sharp easing in risk assessment or declining interest rates. In this case, you may get a near-term spike in the share price.

However, for long-term investors, lower yielding, higher growing dividend stocks may be a better choice.

The key in either case is to focus on their respective free cash flows.

Joe Eqcome

Sep 24 10:14 PM

[Rich H:]

One category that you leave out is preferred stocks. Even after the big run up in stock prices since march, preferred stocks are yielding between 6 and 12%. The choices are great, including investment grade stocks.

I own over 30 preferred stocks with an average yield of approx 9%. Just curious why you are leaving these out of your portfolio and your discussions?

Rich

Sep 25 11:24 AM