The perils of funds that narrowly target high-yielding stocks

Putting too much emphasis on dividend yield can harm the total return of your equity income investment.

Adam McCullough, CFA 29 August, 2017 | 5:00PM

It's easy to understand the allure of dividend-paying stocks. Dividend payments can help investors manage behavioural issues such as their reluctance to realize capital gains to meet income needs, and may give them the fortitude to weather market volatility.

But focusing narrowly on dividend yield can increase risk. For example, the highest-yielding stocks could be under financial distress and thus may be more likely to cut their dividend payments than their lower-yielding counterparts. Many high-yielding stocks pay out a large share of their earnings as dividends, leaving a small buffer to cushion these payments if their business deteriorates.

A high dividend yield looks attractive at first blush, but it's also important to remember that dividend yield is a ratio: the dividend payment (numerator) divided by the stock price (denominator). A company's dividend yield increases when the dividend payment (numerator) is unchanged, but its stock price (denominator) decreases.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
ConocoPhillips35.87 USD-0.61

About Author

Adam McCullough, CFA

Adam McCullough, CFA  Adam McCullough, CFA, is a manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers passive strategies.

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