Why dividends shouldn't dictate your investment strategy

For as long as I can remember it has been general practice for investors, especially retirees, to invest in high dividend paying stocks to generate income. While there is some merit with this strategy, I could argue the opposite.

It has often been a good strategy to be a long-term holder of banking stocks to collect dividends but over the past five years banks have been falling heavily. Another example is Telstra, which has fallen over 60 per cent for almost a decade although it has been rising over the last couple of years.

When a stock falls heavily its dividend yield increases, which makes it attractive to investors. But the question you have to ask yourself is: is it smart to invest in a company that is falling in value?

Think about it, why would you invest in a stock to receive a 5 per cent dividend yield when the price of the stock is falling significantly more than the dividend you would receive? It just doesn’t make sense.

If we look at three of the Big 4 banks including ANZ, NAB and WBC, the fall from their 2015 highs is well over 50 per cent, while CBA is down over 30 per cent. In March of this year, they all fell further in price with the coronavirus crash, and their dividend yields have risen as a result. ANZ, NAB and WBC were all paying a dividend yield over 9 per cent while CBA was paying a yield of over 6 per cent.

Now here is the kicker: investors want certainty, and when they see a high dividend yield they expect they will receive this year in and year out. Unfortunately, this is a false assumption. When the share price is falling, this often means that the earnings of the company are also falling. Consequently, the dividend payout will often be reduced or cut altogether.

In the current market conditions we know that banking dividends are not only in jeopardy of being reduced but in some cases they are in danger of being cancelled altogether. So this begs the question, does the practice of dividend investing still have a place in your investment strategy. In my opinion, it is far better to make the decision to invest in stocks that are rising first rather than simply looking at the dividend yield.

So what are the best and worst performing sectors this week?

While all of the sectors in the Australian stock market have traded down this week, things are not as bad as you might think. Currently, Utilities is the top performer down around 2 per cent followed by Materials and Consumer Staples, both of which are down over 3 per cent so far. The worst sectors for the week include Industrials and Healthcare, as both are down over 6 per cent followed by Consumer Discretionary, which is currently down over 5 per cent. While this sounds bad, the downward move so far has been orderly rather than driven by panic, which is a good sign.

Looking at the ASX top 100 stocks, Evolution Mining is currently topping the list up nearly 7 per cent followed by Northern Star Resources up over 5 per cent, while Crown Resorts, Ausnet and JB Hi-Fi are all just in the green so far this week.

Not surprisingly, the worst performers include Flight Centre down over 16 per cent as is Reliance Worldwide, while Lend Lease and Stockland are both down over 13 per cent.

So what's next for the Australian share market?

For the first three days of this week the Australian stock market was down around 7 per cent, before finding support and rising. Last week, I mentioned that the market was indecisive and showing signs of weakness, which has been confirmed by the downward move this week.

Right now, it is a very interesting time in our market, as what unfolds next will signal what we can expect over the coming month or more. If the All Ordinaries Index can stay above 5000 points over the next week or so and start to rise, then it is more likely we will experience a more sustained rise over the next month to six weeks.

That said, we still need to be mindful that we may not have seen the end of the current crash; therefore, I cannot discount that the market may fall below the low of 4,429 points set back on 23 March.

So, while the market is looking a little more positive, we are not out of the woods yet and it will only take some bad news for another wave of heavy selling to occur, which is why I continue to encourage you to be patient until the dust settles.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also the author of Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in bookstores and online at www.wealthwithin.com.au