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Amateur investors often bring up a common objection to buying elite dividend-paying businesses. Acting on this objection often leads them into very risky investments.
Most elite dividend payers sport annual dividend yields in the neighborhood of 2%–5%. And these yields are incredibly safe and reliable. They rise every year.
In addition to elite dividend payers, the stock market contains groups of businesses that pay annual yields of 6%… 8%… 10%… even 12%.
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The amateur looks at these numbers at says, “Why buy a business that yields 4% when I can buy one that yields 8%?” And then, the amateur makes one of the biggest investment mistakes in the world.
They “chase” yield.
There’s a classic piece of investment wisdom about chasing yield. It goes: “More money has been lost chasing yield than at the barrel of a gun.”
Chasing yield is the act of buying stocks simply because they offer high yields… while ignoring vital business factors.
Some businesses engage in risky business ventures or take on lots of debt in order to pay high yields. Finance and real estate companies often do this.
Some businesses own oil & gas wells and pay dividends from the production. Those dividend payouts are often totally dependent on oil & gas prices staying elevated. They can be incredibly volatile.
These businesses are usually very dangerous for the average investor.
For example, there is a group of companies whose chief business activity is borrowing money at low interest rates… and then using that borrowed money to buy mortgages that pay higher interest rates. They make money from the “spread” between the two.
One of the largest and most popular of these companies is Annaly Capital Management (NYSE:NLY).
Annaly is probably operated by good people. But because it borrows lots of money to buy mortgages, its business — and its dividend yield — is very volatile. Small changes in the business (like how much it has to pay to borrow money) can cause enormous changes in shareholder returns.
Below is a chart of Annaly’s dividend payments from early 1998 to early 2019. As you can see, these payments are incredibly volatile.
The volatile nature of Annaly’s dividend payment leads to volatile share price movement. Below is a chart of Annaly’s share price during the same time period (early 1998 to early 2019).
The volatility in the early 2000’s and around the 2008 financial crisis is par for the course, given what was going on in the market.
But even after the recovery in 2009 — note the drop from $19 per share to $10 per share.