Why Chasing Yields Will Lead to Disappointment

|
Includes: ABT, GD, JNJ, KMB, NKE, PAYX, PG, SYY, UTX
by: Jim Wright, CFA

“More money has been lost reaching for yield than at the point of a gun”

I first came across this quote years ago in a piece written by Ray DeVoe. Ray was a wonderful writer whose financial newsletter was one of my favorites. I think about his quote whenever I hear someone tell me about a safe, secure investment with a huge yield or large promised return.

I think about it because I know that if the yield or promised return sounds too good to be true, it is too good to be true. I have passed on this advice many times in my career, and it has usually proven accurate.

Unfortunately, I am hearing about these “great” investments way too often. It is not surprising, given the very low yields on bank deposits, money market funds, CDs and high quality bonds. People are seeking higher and higher yields and their search will likely lead to disappointment.

Now, we are investors who seek out attractive yields on stocks that we buy. We are very comfortable with the academic research that shows that investing in dividend paying stocks, particularly ones that grow their dividends, has led to above market returns over time. But we are also aware that there is research that shows if you seek out the very highest yielding stocks, you are very likely to set yourself up for poor performance. Why is that? Because strong, well run companies do not have to offer extraordinary yields to attract investors. Low quality companies do, and while investing in them may pay off, the odds are not stacked in your favor.

When we pick investments for ourselves and our clients, we would prefer to have the odds in our favor. As we mentioned above, stocks that pay dividends and grow their yields tend to outperform the market. So if we can find those dividend paying companies with solid businesses, good balance sheets, predictable cash flows and trustworthy management teams, we feel pretty good. If we can find those companies and patiently wait until they are selling at low valuations, than we are pretty confident that we will obtain attractive returns over time. We don’t feel the need to chase super high yields from stocks or bonds, because we recognize we are putting our capital at risk.

Some examples of companies that meet our criteria:

2009 PAYOUT
PRICE EST EPS P/E YIELD RATIO ROE
ABBOTT LABS (NYSE:ABT)
44.47 3.69 12.1 3.6% 46% 29.7
GENERAL DYNAMICS CORP (NYSE:GD)
53.56 6.14 8.7 2.8% 23% 24.7
JOHNSON & JOHNSON (NYSE:JNJ)
59.23 4.52 13.1 3.3% 41% 30.4
KIMBERLY CLARK CORP (NYSE:KMB)
54.47 4.11 13.2 4.4% 59% 35.5
NIKE INC (NYSE:NKE)
52.44 3.54 14.8 1.9% 32% 21.5
PAYCHEX INC (NASDAQ:PAYX)
25.36 1.32 19.2 4.9% 84% 39.8
PROCTER & GAMBLE CO (NYSE:PG)
55.92 4.23 13.2 3.1% 45% 17.4
SYSCO CORPORATION (NYSE:SYY)
22.91 1.73 13.2 4.2% 53% 32.5
UNITED TECHNOLOGIES CP (NYSE:UTX)
53.80 4.07 13.2 2.9% 33% 27.7

Disclosure: As of the authors and clients of Harvest Financial Partners own ABT, GD, JNJ, KMB, NKE, PAYX, PG, SYY and UTX. Positions may change at any time. These are NOT recommendations. Our blog is for informational purposes only.