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As an older investor looking for passive income, I like dividend stocks. In reality, most of my family's unearned income today comes from these cash payments that companies make to their shareholders.
The Disadvantages of Dividend Investing
In an ideal world, you could make money simply by buying stocks that offer better-than-market dividends. Unfortunately, this world is far from ideal, so this is not a “get rich quick” scheme.
For example, here are six problems I have to deal with as a dividend disciple:
1. Only some stocks pay cash
Almost all top stocks FTSE 100 The index pays dividends. However, this ratio is rapidly reducing as I move towards mid-cap. FTSE 250 and smaller companies. That's why Footsie is my number one hunting ground for cash flows.
2. Payments are not guaranteed
Unfortunately, future unpaid dividends are almost never guaranteed. Therefore, they can be cut or canceled with little prior notice. This happened a lot during the Covid-19 crisis and continues today among businesses that need to preserve cash.
3. Returns are usually historical
When looking at the dividend yield of a particular stock, it is important for me to establish whether it is a residual (historical) or expected (future) yield. Additionally, if a company has recently reduced its payments, this may not be entirely evident, which is why I always dig deeper into their public announcements.
4. The curse of dividends
Sometimes publicly traded companies that pay out large proportions of their profits in dividends do not invest enough in future growth. When this happens, I occasionally notice it by spotting long-term declines in stock prices over, say, three and five years.
I call this effect (large dividends undermined by falling stock prices) the “dividend curse.”
5. Debt and divisions
Paying large sums of cash to shareholders over time can make a company's balance sheet appear unstable or stretched. Additionally, some companies prefer to increase their net debt rather than cut payments to their owners.
6. The fall of the ex-dividend
The ex-dividend date is the day on which new shareholders no longer receive the next dividend. Therefore, buying shares before this day guarantees me the dividend, while buying on or after the ex-dividend date means I don't collect it.
Therefore, stock prices typically fall on ex-dividend dates to reflect the loss of this cash reward.
Vodafone's dividend dilemma
A classic dividend stock is Vodafone Group (LSE: VOD), the largest telecommunications operator in the United Kingdom. My wife and I bought these shares in December 2022 for 90.2 pa.
On Wednesday 20 March, Vodafone shares closed at 67.28p, valuing the group at £18bn. To date, we have suffered a paper loss of more than a quarter (-25.4%) in our purchase. Furthermore, this stock has fallen 27.2% in one year and 54.3% in five years (excluding dividends).
Notably, the company's annual dividend payment has been frozen at €0.09 (7.7 pence) per share since 2019. This lack of growth may be a warning sign of upcoming cuts. As it happens, the group has just announced that it will reduce this payment by half in 2025, thus halving the dividend yield from 11.6% to 5.3% per year.
That said, Vodafone intends to buy back €4 billion of its shares using the proceeds from the sale of non-core businesses. Therefore, I have no intention of selling our shares in the immediate future!