Should you invest in companies with
a very high dividend yield?
Is a sudden peak in dividend yield
a once in a lifetime opportunity to buy a stock,
or should you stay away from it?
Find out in this Finance Storyteller video!
Once upon a time, in a land not so far away,
a "reliable and stable" company, let's call it Stabilicom,
had been cruising along nicely for years,
maybe decades, maybe even more than a century:
slow but steady revenue growth,
profit growing faster than revenue due to cost control,
and a dividend yield on the high end
of the market average.
Time after time, the CEO of Stabilicom told the
financial community that his company was
the hallmark of stability, even in times of
economic turbulence, and had exciting
growth opportunities ahead.
Then one day, the company issues a profit warning:
it missed its numbers for the quarter, and revises
the full year estimate downward significantly.
The market reacts in a panic: if even Stabilicom
couldn't deliver on its commitments, who would?
SELL, SELL, SELL!!!
The Stabilicom share price drops sharply,
dragging other stocks and the overall index with it.
One investor, let's call him Joe, keeps his calm,
and recognizes that the sign for danger
and the sign for opportunity are closely related.
Joe decides to buy some shares in Stabilicom.
After all, hadn't the CEO of the company just said
in an interview that the profit warning was
"just a pause before growth resumes",
and that "the dividend is secure"?
And now that the share price has dropped so much,
the dividend yield on Stabilicom shares
looks very attractive to Joe.
Right around that time Joe starts dating
a seismologist named Jane.
On one of their first dates, Jane explains to Joe
some of the basics of studying earthquakes.
When Jane mentions the term "aftershocks",
Joe realizes that earthquakes and aftershocks are
a very appropriate metaphor to use when describing
stock market declines, and Joe decides to sell
his shares in Stabilicom the next day,
just in case an aftershock occurs.
With the benefit of hindsight, Joe realizes his timing to
sell the shares was great, as the Stabilicom share price
drops very sharply once again when its CEO has to
admit in a second profit warning that
the company's trouble in growing revenue and profits is
of a more permanent nature, and Stabilicom
has to cut its dividend payment to shareholders, as it
needs all the cash it can lay its hands on to ensure
business continuity: its ability to pay salaries
to employees and pay bills to suppliers is at risk!
Joe and Jane lived happily ever after,
Stabilicom changed its company name,
and the future of the CEO is as yet unknown.
Rumors are that he might be leaving the company
"to spend more time with his family".
So what does this tale look like
from a graphical standpoint?
The share price is on the left,
dividend in absolute amount in the middle,
and dividend yield percentage on the right.
Stabilicom started off with a share price of $100,
a dividend of $4 per share per year,
and hence a dividend yield of 4%.
The share price dropped after the first profit warning.
The share price is a function of investors' perception
of a company's future.
After the profit warning, the future did not look as bright
as it did before, so the share price dropped to $50.
At the time of the profit warning, the dividend was said
to be secure at $4, therefore the dividend yield
spikes to 8% ($4 dividend on $50 share price).
At the second profit warning, the future of the company
looks even less bright, pessimists or realists would even
say gloomy, and the share price drops to $25.
Due to the cash flow problems of the company,
the dividend is cut from $4 to $1.
The dividend yield goes back to 4% ($1 dividend on
$25 share price), but even though the dividend yield
is back at the old level of 4%, you have had
a very rough rollercoaster ride downhill
if you stuck with the company as an investor.
What is the moral of our high dividend yield fairytale?
Beware of "once in a lifetime dividend yield
opportunities", if they look too good to be true!
I hope you enjoyed this short video about
unusually high dividend yields.
I have many more videos available on my channel,
that can help you in doing your analysis of
financial statements before investing.
On this end screen, there are a few suggestions
of videos you can watch next.
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