A High Dividend Strategy is structured to provide for the higher cash flow needs of the income oriented investor. The strategy seeks to provide both a stable and growing income stream while also giving clients less volatile participation in market movements, while providing principal protection during periods of rising interest rates.
However, with all investment stories, there are caveats and these are the most significant ones for High Dividend Strategies:
- Dividends are not legally binding: Unlike coupons on bonds, where failure to pay leads to default, companies can cut dividends without legal consequence.
- Liquidating dividends: When companies are in decline, they may pay large liquidating dividends, where assets are sold to fund the dividends.
- Dividend yield for a share shoots up mainly due to price drops, not because the dividend is increased. Sometimes price drops occur because there is trouble looming on the horizon.
- Higher tax liability: At least in Switzerland, dividends have been taxed at a higher tax rate than capital gains.
- Sector concentration: If you pick the highest dividend yield shares, you may find yourself holding shares in one or two sectors. In early 2008, for instance, you may have ended up with five banks in your portfolio. Considering the shock to that sector end 2008, your portfolio literally collapsed!
By screening tax-advantaged, dividend paying shares, for suitable candidates with a market-cap greater than CHF 5 billion, above average dividend growth, investment grade debt rating, and candidates that have not have been forced to cut their dividend over the past 5 years, should provide confidence that the dividend payout is sustainable.
Once a candidate has been identified, a thorough fundamental analysis of the company focusing on valuation and key balance sheet and income statement information should be conducted.
With such an approach, you can construct a reasonably diversified portfolio by owning 30-40 securities spread across sectors, although higher dividend sectors such as for instance utilities will have larger representation.