But don't get fooled by YIELD.
Plenty of stocks look attractive at first glance, when you see they have a high yield. Look under the hood, and they may be in a pronounced downtrend, stock price in near free fall. The yield is phony, based on a divident payout previously given, but the next dividend will be cut, or eliminated.
There was an infamous company (Fieldstone) that sported a 17% yield in the throes of the financial crisis. So the books stated. You bought it, and you never got any dividend. They went bankrupt quickly after.
Originally Posted by Chung Tran
Yes, if shares are cheap, you need to know why they're cheap.
There are a lot of reasons why high dividend yields may deceive. You brought up one, I think (I'm not familiar with Fieldstone), too much debt and a downturn in business.
Right now you're going to see coal exporters, refiners and bulk shipping companies paying generous dividends. But when coal prices, refining margins and shipping rates go down, so will the dividends. The market realizes this and so they sell at high dividend yields. Still, for some of these companies, it's possible the dividends you'll receive in the next few years may justify the share price. Some are probably cheap.
Some companies will juice the dividend yield so the insiders can dump shares. This is common with some Chinese companies listed on foreign exchanges. Some are frauds. You can guard against this by being careful with companies that haven't been listed and traded for a long time -- probably one of the reasons CM prefers companies that have paid good dividends for many years.
Resource companies can be sitting on key mines and oil fields that have low reserve/production ratios. That is their gold or oil or whatever is about to play out. So they too can sell at high yields, for a reason.
Capex and working capital investment have a big effect. If a company was minting free cash flow and then decides to embark on a major project or expansion or acquisition, it may cut or omit dividends, and may in addition go deep into debt. If the return on their additional investment is poor, it may be a long while before you see good dividends again.
In addition to future capex and other investment, keeping an eye on net debt is a good idea. Once a company pays down debt dividends are likely to increase, and vice versa.
Read the disclosure and analyst reports, find out if they have a dividend policy, try to talk to the investor relations person or management. It's not a bad idea to talk to competitors, suppliers and employees too, although I'm usually too lazy to do that. All these help to understand not only what's behind the dividend, but the prospects and fundamentals of the company. You're buying a share of a business so you want to understand the company.
You want to be forward looking. Yes, there are empirical relationships, which haven't worked as well in recent years because of the market's obsession with growth, like historical price/earnings, price/book, price/free cash flow, and dividend yield. But what you'd really like to have a handle on are earnings, free cash flow, and dividends going forward. And how management treats shareholders and what it does with its free cash. Those are what drive share prices, or at least should drive them.
