Do High Yield Stocks Mean Lower Returns?

It is a common understanding among dividend investors that high yield stocks typically have meant lower capital gains than lower dividend yield stocks. The thinking is that very high yields signal trouble with a company that ultimately leads to lower stock returns.

A recent American Association of Individual Investors (AAII) article from May 2009 (subscriber status required) provided some interesting research that show that is not always the case.

In fact, they show in their research that the higher-yielding stocks in their study had an average gain over the 4.5 year time frame of 32% and a midpoint of 19.7%. The lower-yielding stocks had an average loss of -1.4% and a midpoint return of 2.2%). During the same period of the study the S&P 500 index grew by 15.2% and the DJIA was up 8.6%. It appears that the high yielding stocks had an edge in terms of capital gains. This is very different to the common wisdom we all tend to hold that higher dividend yields equals more risk. You can see the data prepared by the AAII in the table below:[ad#tdg-embedded]

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What is very important about this study is what is considered to be high yield and what is low yield. High yield is any stock over 2% and a low yield stock has a dividend yield under 2%. So what we see from this study is that for those stocks paying dividends over 2% then there has been no evidence of reduced capital gains. In fact, within the confines of this study the returns for those stocks have actually been better than their lower yielding counterparts.

The article also confirms that our long standing believe that very high dividend yields still signal trouble for a company and should be seriously scrutinized before an investment decision is made. A stock with a dividend yield of 6% or higher falls into this camp (unless we are talking about REITs).

This article does not necessarily change any of my tactics in my own dividend investing. However, it does further help to verify my dividend strategy and focus on companies with a yield over 2%. That being said, I do not invest based on yield alone and would rather see a long history of strong dividend growth and other positive fundamentals before investing in any company.

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