Last Updated on 15, August 2017
https://youtu.be/Wez8tdfBCgk
If you prefer to read, the following is the transcript of the video:
I have come across many young investors who invest in high dividend yield stocks. This is not appropriate for young investors due to three reasons:
First, as large part of company’s cash is distributed back to shareholders, little amount is left for the company to reinvest in existing and new projects. This means it has low earnings growth. What the investors is investing are low growth stocks. Many growth stocks pay little or no dividends. Moreover, investors should always consider the total return – which is the sum of capital gain and dividends collected. It is incorrect to focus on dividends while totally ignore the capital gains. For young investors, time is their friend. By focusing in low growth stocks, they fail to make use of the power of compounding.
Second, some people felt that “a bird in the hand is worth two in the bush”. They feel it is better to receive dividends which are real cash than to enjoy capital gains which are mere paper gains. Many investors fear that the companies which they invest may be mismanaged and thus it is better to get cash now than to enjoy a paper gain. The issue of the company collapsing is called non-systematic risks which can be completely eliminated through diversification. The issue of non-systematic risk should be address at the portfolio level. It incorrect to manage non-systematic risk at the stock level by demanding high dividends since non-systematic risk can never be removed at the stock level. Moreover, this “bird in the hand” approach is related to a human bias called ‘Self-Control’ which is well documented in behavior finance. Such a bias behavior tends to produce non-optimal decision making process.
Third, sometimes investors get confused between dividend yield play and value investing. It has been said that undervalued companies are sick companies which the market dislike. But I want to caution here that dividend yield play and value investing are not the same. A value investor seeks to look out for firms which have been mispriced by the market - dividend is not the primary focus. In fact, a loss making company which is unable to pay a single cent of dividend could have the potential to recover and earn a handsome profit resulting in huge capital gain for the shareholder when the market finally appreciate the true potential of the firm. Thus, value investing is not a high dividend yield investing although there is a tendency for high dividend yield investors to end up buying undervalued companies. Hence, those who are not careful could end up with a concentrated portfolio towards value investing although the primary objective was supposed to be dividends. Due to the greater risk in value investing, the investor may not be prepared for massive losses that could incur due to investing in ‘sick’ companies.
My advice to young investors is to expand their investment knowledge towards a more holistic approach than to narrowly focus on one school of thought. When in doubt, always consult a professional investment adviser. 
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I would modify to say go for high-div stock but get those that are run well and have a business model for continued growth. There is some correlation of high-div also being growth stock – just need to find these.
Usually these are not the super high-dividend but reasonable amount of 3 to 5%. SATS and SIA Engineering were of these type when their prices were lower.
‘there is a tendency for high dividend yield investors to end up buying undervalued companies’.
Can I find out why is this so?
Thank you.
The formula for dividend yield is = D/P where D is the historical dividends and P is the current price.
A high dividend yield could mean high D or low P.
If it is low P, it could mean the stock is “cheap” i.e. undervalued.
But low P can also mean the stock is in distress and is about to collapse.
Thanks for the clarification Wilfred.
Much appreciated.
Wilfred: I very much agree with your big idea of looking at Total Return when investing instead of narrowly focus on merely high dividend yield. However, isn’t it true that companies which are capable of paying dividends are ‘strong’. Strong in the sense of having excess cash to pay out to shareholders. Some companies are also increasing their dividends year after year (i.e. MacDonald) for the past decades.
Why are you not advocating high dividend stocks to investors?
abc: high-div stock paying 3-5% is great but l think we should look out for companies paying suspiciously more than the return of the market, least it collapse.
A company that can increase its dividends every year is because it has positive earning growth. The Positive earning growth is possible because it does not pay out all its earnings through dividends.
g = Retention Rate x ROE.
If a company pays out large amount or all of its of dividends, the Retention Rate is zero. Hence g = 0. This means its dividends has 0% growth. After net of inflation, the dividends are actually declining. Ironically, a company paying large amount of dividends consistently could what we call no growth stock. After netting of inflation, it is a sunset company.
By the way, don’t get confused over dividend yield and the cost equity (or shareholder’s required return). They are not the same.
http://www.ifa.sg/myths-dividend-yield-investing/
Appreciate your clarification, Wilfred.
So you do advocate the purchase (and holding onto) of dividend stocks, so as long as they have positive earning growth in the medium term?
This depends on individual investor’s situation, risk tolerance and financial goals. Can’t answer this question as it would construe as investment advice.
Besides, any investments have to be meaningful. No point investing just a 100K when the retirement goal is $2m. Better to spent the money in one’s education like a MBA or attending networking session to improve one’s career which would yield a huge amount in potential increase in salary.
Here is a recent article which provide evidence why high-dividend yield strategy turns out to be value investing: Swedroe: Are Dividends A Value Strategy?