Daily Gains Letter

High-Yielding Stocks Are One Big Trap—Don’t Let Someone Sell You on Yield

By for Daily Gains Letter | Feb 11, 2013

















DL_Feb_11_2013_MitchellIf you are in retirement and you own equities for income, the one thing you have to watch is buying stocks solely for their dividends or yield. It is difficult to generate income these days with the Federal Reserve’s artificially low interest rates. In a lot of cases, stock market dividends are the only way for a retiree to generate income and have some hope of growing their capital over time.

Consider, for example, these two great technology stocks. Both Microsoft Corporation (NASDAQ/MSFT) and Intel Corporation (NASDAQ/INTC) are blue chip companies that pay dividends. Microsoft is currently yielding 3.3% on the stock market, while Intel’s yield is higher at 4.2%. For any mature business, these are very good yields; but I wouldn’t recommend buying these two stocks, because their growth prospects are minimal.

In terms of its share price, Microsoft hasn’t done a thing on the stock market for the last 13 years. The company’s earnings are becoming more inconsistent, and I would argue that the position is actually fully priced on the stock market, even though it’s trading near its 52-week low. Microsoft’s stock chart is below:

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Chart courtesy of www.StockCharts.com

Intel’s long-term stock market chart is virtually identical to Microsoft’s. Even though Intel’s dividends are attractive, the stock isn’t going anywhere, because investors don’t see how the company can grow going forward, especially with the prevalence of Apple products, tablets and smartphones. The personal computer (PC), it would seem, is one its way out.

So it pays not to buy a stock just for its yield. The key to a successful investment in the stock market is for a company to offer real growth prospects, in terms of its operations, and the potential for increased dividends over time.

Compared to Microsoft, PepsiCo, Inc. (NYSE/PEP) has been a much better performer on the stock market over the last 13 years. And this doesn’t even include reinvested dividends. PepsiCo has been increasing its dividends consistently over time; and the wealth creation becomes way more significant if you didn’t need the income and reinvested these dividends into new shares.

If you check out the PepsiCo web site, (https://www.pepsico.com/Investors/Shareholder-Information/Dividend-Information.html), you’ll see the consistency in which PepsiCo has been increasing its dividends to shareholders. It’s a powerful case to be made. Turns out, the soda business is much better than the computer business.

A lot of investors get caught buying a stock for its yield, rather than considering the company’s underlying fundamentals. The stock market is littered with companies that haven’t done anything except pay high dividends. It just isn’t the route you want to go in an equity portfolio.

A company that offers dividends producing a yield over four percent is pretty darn attractive. But the proven blue chip wealth creators, many of which are Dow stocks, don’t offer yields this high, because they use their cash to also grow their businesses. The next time a broker or other participant wants you to consider a stock market investment based on its yield, think again. The best wealth creators over time offer both dividends and solid growth prospects.

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