Dividend Investing: High Yield or Distribution Growth?
Editor’s Note: We’re shaking things up this week.
When it comes to expert dividend investing advice, we usually defer to our friends at Wealthy Retirement – another of The Oxford Club’s free e-letters.
And this week, we’re dying to know: Should we seek dividends with high yields… or high-growth prospects? Where do the best income-producing opportunities lie?
Here to answer all our questions is Senior Research Analyst Kristin Orman.
– Rebecca Barshop, Managing Editor
There are two types of dividend investors out there: yield grabbers and growth groupies.
But the most successful dividend income investors I know capture both.
Income-hungry investors aren’t satisfied with receiving a paltry 2% dividend yield.
I don’t blame them! Earning 2% a year barely covers inflation, and doesn’t begin to approach the 10% price hike on a cup of coffee that Starbucks (Nasdaq: SBUX) imposed last year.
That’s why many investors gravitate toward high-yield dividend stocks. For the sake of this argument, I’ll define high-yield stocks as those with yields greater than 4%.
I call these investors “yield grabbers.” They’re looking to cash a big dividend check right now.
Telecommunication and utility companies, master limited partnerships, and real estate investment trusts often have high yields. They also have slower dividend growth.
These companies, and the products or services they provide, are often natural monopolies. Some examples are oil and gas pipelines, telephone lines, and internet connectivity. But with such stocks, government regulation or other factors often limit profit and dividend growth.
But not all high-yield stocks make good investments. Some of them are downright dangerous.
We call these stocks “yield traps” because the companies are in trouble. They have high debt loads and declining sales, and they cannot afford to keep paying their lofty dividends for long.
Yield trap dividends are unsustainable and make horrible investments. If you invest in these stocks, you’re likely to lose money in two ways. The first is an income hit when the company cuts or eliminates its dividend to preserve cash. The second is a principal hit as the price of the stock continues to fall with the company’s declining business performance.
Yield grabbers must be experts at spotting and steering clear of yield traps if they want to build a lasting dividend income stream.
But avoiding yield traps doesn’t guarantee that yield grabbers will have enough to get by in the future.
While higher income today is great, it’s also important to have much higher income tomorrow. Unfortunately, most high-yielding stocks don’t fit that bill.
Typically, high-yielding stocks have slower distribution growth. They raise their dividends just a few percentage points each year. Some high-yield stocks haven’t raised their dividends in years (if ever).
Yield grabbers usually dismiss low-yielding stocks. They often won’t invest in a dividend stock with a yield below 2.5% or 3%.
It’s understandable in some cases.
Low-yielding stocks don’t generate enough income right now for yield grabbers. If you’re in or near retirement and depend on dividends to pay your everyday bills, a paltry 1% to 2% yield doesn’t cut it.
But here’s the good thing about some lower-yielding stocks…
They typically grow their dividends at a much faster pace than their high-yield counterparts. Some lower-yielding stocks even double their dividends every single year! This is especially true of new dividend payers.
That’s why growth groupies love them.
You can blame it on the law of small numbers. If the dividend is small to begin with, even a tiny increase will be a big percentage gain.
Let me show you how it works…
A $0.05 raise on a $0.05 dividend means that the company increased its payout by 100%. That doubles your yield on your cost basis if the number of shares you own stays the same.
(As a refresher, yield on cost is calculated by dividing the current annual dividend by the price you paid for the stock.)
Higher-yielding stocks, on the other hand, often have larger dividends in terms of dollar amounts.
That same $0.05 bump on a $1 dividend means that the company increased its payout by just 5%. In this case, you get a lot less bang for your invested bucks and may actually lose spendable dividend income as inflation rises.
Thankfully, Chief Income Strategist Marc Lichtenfeld discovered a strategy that makes both types of dividend investors happy.
He’s found the best and fastest track to enormous dividend yields and returns.
Marc has identified a select group of stocks that pay what he calls “Extreme Dividends.”
Extreme Dividends are dividends that rise so high and so fast that they wind up paying you more than your initial investment every year.
Arlington Asset Investment Corp. (NYSE: AI) is one example of an Extreme Dividend.
The company increased its dividend so fast that a $5,000 investment began paying out $7,945 in dividends every year to investors.
That’s a 158% yield on your cost basis!
Arlington Asset is just one of many Extreme Dividends that Marc has uncovered.
Owning just a few Extreme Dividend stocks could easily replace the income from a full-time job!
Marc is sharing his three favorite Extreme Dividend companies to buy right now. Click here to find out more about what could be Marc’s most profitable discovery yet.
When it comes to dividend investing, you don’t have to choose between the two most profitable strategies. You can have both!