Daily Money Minute

Fotolia_54867638_XS_7“Be cautious of companies with ultra-high dividend yields.” ~Roy Sutton

There are many theories for achieving financial success by investing in stocks and shares. Personally I am a fan of value investing and a key measure of value is the dividend yield of course. Generally I am looking for great companies with great products run by great people. I am looking for cash generative companies at the right price with a decent dividend and the potential for that dividend to grow over time. So you might think that if a company is paying a dividend that is way above the market average then that is the sign of a good investment based on value investing principles. Well, maybe! Certainly I am looking for dividends above the market average. However I am wary of companies paying a dividend over twice the market average. You have to ask yourself, “Why are they paying a dividend quite so high?” Why are they not reinvesting some of that money to grow the company over time? What is that I don’t know? I am looking for the potential for dividend growth over time. How can I be confident that will happen without some reinvestment of profits? The problem with a situation such as this is that in the event of an economic downturn, management can use it as an excuse to slash the dividend quite severely. And if that happens the share price goes down too. I am not saying I wouldn’t buy a share with an ultra-high dividend yield but I would put the company under the microscope and I would want to be absolutely sure I understood why the dividend was justified. If I couldn’t be sure, I wouldn’t buy.

© RJ Sutton and Mann Island Media Limited 2014. All Rights Reserved.

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