5 Avoidable Mistakes Before Earning Dividends

I don't often give the pen to other writers, but today I decided to give the place to Sovanna Sek, a blogger and independent investor with whom I have already exchanged several times in the past, here and elsewhere. Sovanna has just launched a new site. As it is very recent there is still little material, but I have no doubt that it will expand its offer very soon. Enjoy reading.

On the stock market, dividends are a source of income within your reach.

In times of crisis, it constitutes a lifeline for your stock portfolio. When everything is going well, it contributes to the stability of your performance. Historically, the evolution of dividends is less volatile than profits.

Based on this observation, building a dividend strategy can be one of the best ways to invest in the stock market with peace of mind and enrich yourself in the long term.

However, don't get too excited or you'll be blinded by the jackpot.

To help you master it, here are some avoidable mistakes to avoid.

Mistake #1: Falling for high-yield stocks

When it comes to money, you have this bad habit of wanting the biggest pie.

It's the same on the stock market. You're very attracted to high-yield stocks. Getting dividends at 5 %, 6 % or 7 % is a hell of a lot better than 2 or 3 %. Not always, unfortunately.

The problem with high yield is that it can turn into a nightmare..

What you need to do before naively investing in this category of values is to know the different reasons for the high level of return.

Reason #1: The company's fundamentals may have deteriorated significantly. This leads to a fall in its stock price. With a dividend maintained by management's empty promises, the yield increases mechanically.

Reason #2: Un rendement élevé peut s’expliquer par une politique de dividende fixée par l’entreprise. Par exemple, Les foncières versent entre 80 et 90 % du résultat net selon le régime SIIC (Société d’investissement Real estate Cotée).

Reason #3: High-yield stocks have another weakness that the financial media fails to mention. When interest rates rise, they tend to fall. In fact, the yield becomes less attractive because of higher interest rates.

If I were you, I wouldn't want reason #1 to prevail. Beware of disillusionment.

Let's take the case ofEngie which pays approximately 8.94 % for a price of 11.18 € on February 15, 2017.

This is a company that does not inspire confidence in me. First of all, the management organization is incomprehensible because we do not know who is in charge. Secondly, the role of the State as a shareholder leaves something to be desired in its growth strategy. Finally, its business model is very dependent on the price regulation set by the public authorities.

Since I like to drive the point home, here are some images that are worth a long speech.

What might surprise you is that Engie has been considered a high-yield stock since the 2008 financial crisis.

That said, you shouldn't throw the baby out with the bathwater on this type of stock by taking Engie at face value. Fortunately, there are a few exceptions of companies that offer a high and solid yield.

Mistake #2: Swearing by dividend growth

The stock market has this ability to blind you in your decision making.

You are falling into the easy way out. For poorly educated individual investors, the dividend is a criterion of covetousness.

You think that focusing on dividend growth is enough to invest well in the stock market. You could end up with empty pockets.

If you want to receive dividends with complete peace of mind at 99 %, you must first analyze the company both in terms of its business and its finances.

Next, you want to have an opinion on the quality of the dividend the company is paying you. I recommend you take a look at the payout ratio (distribution rate).

To calculate this financial ratio, you need to divide the dividend by the profits.

Many of you are unaware of this.

I will take a recent case on the company Coca-Cola. No need to introduce her to you.

Recently, the world leader in soda has suffered a seventh consecutive quarter of decline. Its stock price has fallen again since April 2016. Why?

Reason #1: Households are changing their consumption habits by favoring less caloric sodas. It could be that it is poorly positioned or very competitive in this niche.

Reason #2: As it is an international company, it suffers from the rise of the dollar against all world currencies. As such, the hegemony of the dollar can be a burden.

Now, let's look at the dividend and payout ratio in pictures.

You see that the dividend is on an increasing slope. So far, so good. However, there are two drawbacks that worry me.

Firstly, profits have been declining since 2010. Secondly, free cash flow/share is higher than dividend/share, but only slightly.

Combining the two issues, you won't be surprised that the payout ratio is at an all-time high of 90 % since 1990.

If it is just my opinion, I would limit myself to a payout of 70 % and no more to ensure that the dividend is sustainable. On Coca-Cola, it has been well above that for 3 years.

Sure, you are convinced that Coca-Cola is a high-quality company because it has proven itself during various crises. I understand that, but the past is not the present or the future.

With a high P/E ratio above 20 and earnings growth declining since 2010, it would be wise to be cautious in the short term.

In addition, it took on heavy debt to buy back its own shares over the period 2010-2014 before calming down over the last two years.

I'm not necessarily saying she's going to drink the cup. Her products are still sold if you go to the supermarket.

In this example, I teach you that a world-renowned company can encounter problems. Sometimes, it is better to wait for short-term improvements to really be interested in buying. This could come from the decline of the dollar. De facto, a drop in the payout ratio would be a good signal.

Mistake #3: Neglecting your ROI with reinvested dividends

You think that your return on investment is limited to the appreciation of the stock price which must be higher than the cost price.

Except you tend to forget that receiving dividends can be part of it.

Unfortunately, the financial media do not know how to sell the stock market to the general public. For example, the CAC 40 Dividendes Bruts Réinvestis (PAR: PX1GR) as of February 16, 2017 is close to its historic peaks while the CAC 40 is stagnating below 5,000 points.

With the ability to reinvest them, you benefit from the magic of compound interest.

If you don't understand this principle that can enrich you. Follow me.

The money you have invested is already earning you interest. If you want to reinvest it every year, new interest will be produced and so on. In fact, you mechanically improve your return on investment. In short, you make your money work for you.

If you own stocks that pay good returns and have strong fundamentals, you can multiply your starting capital exponentially.

Mistake #4: Thinking low-yielding stocks are unattractive

I formally admit that it is counterintuitive to think that low-yielding stocks are, for the most part, the best investments for a dividend strategy. Unfortunately, it is true.

Having 1 or 2 % can satisfy you with stocks that appreciate in the long term. Examples like the French L'Oreal And Essilor, then the Germans Henkel Or Beiersdorf prove it.

You only have to see their graphic evolution over a long period. In addition, these are companies managed by quality management.

Mistake #5: Ignoring the impact of a dividend cut or elimination

In over 7 years of being in the stock market, the worst thing investors hate is the reduction or elimination of the dividend from the company.

When that happens, you can be sure that they will punish it by significantly lowering its stock price. They are merciless.

To be frank with you, this is a bad signal at a fundamental level. Why?

On an industry level, the company is failing to meet the demands of today and tomorrow. This may be competitive or stem from a new trend that it did not see coming.

Financially, it has gotten itself into trouble with poor cash management and has little room to finance its growth with debt.

Personally, for many years I had stocks that had lowered their dividends, such as Cameco, Potash Corporation or Vallourec in my stock portfolio. Believe me, I don't have a good memory. My motto is: Run away at all costs.

Earn dividends: An asset to boost the performance of your portfolio

This is not a joke.

Collecting dividends can be the way to maximize the performance of your stock portfolio.

However, don't think it's easy. You need to do some analytical work up front to find companies on the stock market that pay a solid dividend over the long term.

Focusing only on dividend growth is a big mistake. You need to check the profitability and profitability of the company without forgetting its solvency and cash flow which is its vital heart.

Wanting to help you, I'll give you a hint. Go hunting for companies that have weathered the various economic, financial, geopolitical or monetary crises.

Last reminder.

If you are keen on a high-yielding dividend, you may be dealing with companies that have already cut it before. Take this as good advice.