History shows high yields do not always produce the best returns
Income-seeking investors may be surprised to learn that the highest-yielding stocks can fail to produce the best returns.
According to research by the BlackRock Global Equity Income Fund, less than half of the stocks yielding more than 10 per cent distributed the entire expected dividend over the period of 1976 – 2012.
So investors focusing only on the highest current yields in the markets are doing so at the expense of quality, and may experience lower returns over time.
Stuart Reeve, co-manager of the BlackRock Global Equity Income fund, says: 'Many dividend investors, including dividend-themed funds, focus their search on locating the highest-yielding stocks in the market. The global market yield is currently around 3 per cent, and the logic is often that a stock which generates a higher dividend yield, say 6 per cent, will deliver greater return when compared to a stock which only delivers 3 per cent. Actually the relationship is not that simple.'
He adds: ‘History shows us that an equity’s risk-adjusted return begins to fall when the dividend yield reaches a certain point. By analysing long-term data, we found that the second and third deciles of yielding stocks produced the best risk-adjusted returns, whereas moving to the first decile (the top 10 per cent of yielding stocks) resulted in a significant reduction in returns.’
According to Reeve, as well as being aware that companies boasting high dividend yields may fail in delivering them, investors should be open to companies that have low yields, but have the potential to grow them. A good example of a stock is British American Tobacco. Not only is this company yielding around 4 per cent, says Reeve, but it has been able to grow its dividend by about 17 per cent annually for the past five years.
Jason Witcombe, director of Evolve Financial Planning, highlights another issue for investors that are solely drawn to high dividend yields: ‘Yield is an important part of total return and a high yield clearly sounds more attractive than a low one.
‘However, by its nature this has to mean that something else is being sacrificed which, logically speaking, has to be the stock’s growth prospects given that more profit is being paid out instead of being reinvested into the business.’