Dividend Investors May Want to Be Cautious in Current Market

 |  Includes: MCD, PM, RAVN
by: Kevin Parker

I monitor a number of financial newsletters and investment advisory services. A number of them are focused on income investing, recommending sound dividend stocks. There is a clear trend developing, which I hinted at in my last article, when I mentioned how it is getting difficult to find attractive entry points to dividend stocks.

As stock prices rise on many of the stocks we all watch, the dividend yield for new money drops.

Many of these publications, which offer their readers recommendations to find high yielding investments, are having a tough time finding stocks with decent yield. While it's tough to sell newsletters by recommending sitting in cash each month, the focus of many of these publications is changing.

When an adviser who typically recommends high yielding investments can't find any yield, the focus will often turn to dividend growth as a replacement.

Sure, you can't get a decent yield on your money now, but by buying this stock, you can get that decent yield down the road because this company has an excellent track record of increasing its dividend every year.

Now, don't get me wrong. Dividend growth is one of my favorite aspects when looking into stocks, but this can be a dangerous game for investors. Chasing potentially overvalued stocks in the name of chasing dividend growth can indeed backfire.

The rhetoric we often hear is that we should ignore current market price simply because we have a long-term perspective. We then shift to some charts showing growing earnings and growing dividends and conclude that allocating new money regardless of stock price into this company is a wise decision, and that over time, we're guaranteed to make good money. Fellow Seeking Alpha contributor Dr. Osman Gusleven recently posted a similar article on McDonald's Corp (NYSE:MCD) that fits this description perfectly. Please note that I love McDonald's as a company and agree with most of the author's fundamental analysis of the company.

The reality is that at what level you buy a stock is indeed important within a dividend growth investment strategy. The rate at which your invested capital is compounding is directly correlated to the stock price at which you bought the security (which is correlated to the dividend yield).

By buying an overvalued stock, you're locking in a lower dividend yield. There are a number of companies that I want to own that have run too far in my opinion to warrant buying at any serious levels. Such companies are Philip Morris Int'l (NYSE:PM), Raven Industries (NASDAQ:RAVN) and possibly even McDonald's Corp (MCD). Note: I'm still buying McDonald's but in smaller allotments via a DRIP Plan.

To sum up, emphasizing dividend growth is an excellent strategy, but chasing a stock as it hits new highs simply because it has a track record of growing a dividend might not be the best investment approach. If a stock corrects significantly, it can take a long time to recoup the loss based on dividend growth.

If you follow the economic data that constantly comes out, you know that there are indeed big time headwinds for the macro economy. With the uncertainty over the fiscal situation in Congress and the ending of quantitative easing from the Federal Reserve, this might be a choice time to be patient and see how the markets shake out.

Yes, us dividend investors view investing on a long-term time horizon, and that is exactly why we should be willing to be patient for attractive entry points.

Disclosure: I am long RAVN, MCD.