Dividend Yield Hunters Beware

There are several variables that should be considered when buying a stock. It’s the job of the investor to do research and add importance or weightings to certain special characteristics of a business. For example, I like to put deep emphasis on earnings growth/outlook and the balance sheet. If a company is losing money or deep in debt compared to shareholders equity, I would exclude from buying. That eliminates some stocks right away. I also pay close attention to the price to earnings ratio as related to the growth rate of the company and the return on equity. I like simple, easy to understand businesses. These types of fundamental measures help me effectively zero in on possible investments that pass the criteria. They work for me, and you should find what works for you.

A challenge for the investor is finding out what is really important to whether a stock will be a good investment and putting emphasis on those factors when searching for prospective buys.

I observe frequently investors stressing the importance of yield too much. It’s not that I am anti dividends. I love dividends and a majority of my positions happen to pay dividends. But it is a mistake for the enterprising investor to have strict guidelines for dividends and limit stock holdings to say ‘only stocks that yield more than 5%.’ For example, if you come across a business that has great double digit growth, terrific niche products/brand, room for expansion and great balance sheet, but simply disregard the stock because it ‘only yields 1.2%’, that behavior can leave a lot of good opportunities on the table.

In Canada, there were plenty of opportunities that would have been overlooked if you had a strict dividend rule like the above or were just too dividend oriented in your stock analysis. Some of these include, Dollarama, Lululemon, Alimentation Couche-Tard, MTY Food Group, Tim Hortons, CGI Group.

I am writing this as a first hand offender, as I myself have disregarded some of the above names because of the thirst for yield. I suppose this article is about admitting a mistake and learning from it, which we should all do as investors.

Something should be said about the individual needs of each investor. It makes sense to be yield focused if you plan to retire in 5-10 years. In certain situations buying for yield can be a terrific investment strategy; for instance, if you have a large sum of capital and want to invest it to live off the income. Or maybe you just want to have a more conservative, yield oriented approach because that makes you comfortable; all valid reasons and there are many other situations where yield is good.

However, as an enterprising stock picker with long term capital appreciation in mind, all businesses that can be understood, regardless of the dividend yield should be considered as a possible investment. My recommendation would be to focus more on the fundamentals and think of the yield as a nice bonus – the cherry on top of a wonderful business. It’s more difficult to be successful in stocks if you are overlooking wonderful businesses because of the yield, or lack thereof.