Don't Fall For Big Yields

"More people get killed chasing after a higher yield than by looking down the barrel of a gun." Jesse Livermore was saying it's a mistake to buy stocks with what look like dividend yields far above the norm for their industry group. There are at least two reasons for this. One, the higher the dividend, the harder it is to increase it annually. Two, stocks with high dividends commonly don't increase in price very fast because the money that might have gone for R&D, acquisitions, plant expansion or share buybacks is being paid to shareholders.

Why are annual dividend increases so important? The answer goes back to 1924 when E.L. Smith wrote "Common Stocks As Long Term Investments", based on a study he had done of stock prices from just after the Civil War up to 1922. None other than J.M. Keynes reviewed this book (1925), in which Smith wrote that well managed companies typically retained some earnings over and above what was paid out to shareholders as dividends. These retained earnings were then used to expand the business, which usually contributed to more earnings and higher dividends. Keynes wrote in his review (his italics): "Thus there is an element of compound interest operating in favor of (stocks of such industrial companies)."

Source: Seeking Alpha

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