This is a cautionary tale about how chasing dividends may ultimately lose you money.
What is Dividend Investing?
Dividend investing is a strategy that involves buying stocks of companies that pay regular dividends to their shareholders.
A company distributes a portion of its profits as dividends to the owners of its shares i.e., the shareholders.
The Benefits of Dividend Investing
- Passive income: Dividends can provide a passive stream of income.
- Compounding over time: You can also reinvest the dividends via a dividend reinvestment plan (DRIP). Once you enrol in a DRIP, you can use your dividends to buy more shares or fractional shares of the same company instead of receiving the dividends as cash. The number of shares you can buy depends on the company’s share price at the time plus the value of the dividends the company has paid you.
- Lower risk: Dividend stocks tend to be less volatile than non-dividend stocks, as they are usually issued by mature and stable companies that have proven their profitability and reliability.
The Risks of Dividend Investing
- Dividend reduced or eliminated: A company does not guarantee that it will always pay out dividends to its shareholders. The company may decide to reduce the dividend paid out or eliminate it altogether at any time.
- Share Price Fall: A reduction or elimination of the dividend may affect the share price of the company causing it to drop, potentially dramatically. A share price drop can be triggered as investors flee due to a) loss of confidence in the company as the reduction or elimination of the dividend signals that the company is in financial trouble and has declining growth prospects b) for those investors who solely invested in the company for the dividend they may decide to cash out and move their money into another company that pays a higher dividend.
- Tax: In the UK, dividends are subject to UK income tax unless they are held in a tax-advantaged account such as an Individual Savings Account (ISA) or a Self-Invested Personal Pension (SIPP). Also, the dividend allowance in the UK has been reduced to a paltry £1,000 per UK tax year. This means you could potentially pay more tax on your dividends.
- Slower growth: There may be slower growth amongst dividend paying companies. Unlike growth stocks, they distribute the dividend to shareholders rather than reinvesting the money into the company. This potentially affects the growth of the company and the share price.
Making the Mistake of Chasing Dividends
This is a story about Lumen Technologies (formerly known as Century Link) and how investing in it and chasing its large dividend payments would have ultimately lost you money.
Lumen Technologies (LUMN) is an international telecommunications company that provides network, cloud, security, voice, and data services to businesses and consumers. The company operates in four segments: International and Global Accounts Management, Enterprise, Small and Medium Business, and Wholesale and Consumer.
The company has a market capitalization of approximately $1.43 billion as of September 14, 2023, with approximately 1.01bn shares in issue, Source: MarketWatch.com.
Had you invested in Lumen Technologies (formerly CenturyLink until September 2020) you would have enjoyed dividend yields ranging from a whopping 14.61% on November 14, 2017, to a still very high 10.35% as of May 23, 2019, Source: MarketBeat.com. So, you can see why Lumen Technologies was an attractive option for dividend investors.
What Went Wrong with Lumen Technologies
The company faced several challenges that affected its performance and profitability such as declining revenue and earnings and high debt and interest expenses.
Chasing Dividends – How Lumen Technologies Cut Its Dividend and Hurt Its Shareholders
As a result of these challenges, Lumen Technologies’ earnings declined significantly, and it could not sustain its dividend payments.
In Q1 2019 the company cut its dividend from $2.16 per share to $1.00 per share, to preserve its financial position.
In its third quarter press release on November 2, 2021, the company announced that it would eliminate its dividend effective from Q4 2022.
Many investors waited until the final dividend pay-out on September 9, 2022, before they started selling off the shares. The share price on September 9, 2022, was $9.97.
September 13, 2022, Lumen Technologies announced that Kate Johnson would replace Jeff Storey as CEO with the transition starting on November 7, 2022. On this date, the share price dropped to $6.04.
By March 1, 2023, it had dropped to $3.23 and as of September 13, 2023, its closing price had dropped further to $1.40, Source: Hargreaves Lansdown.
How Lumen Hurt Its Shareholders
If you were chasing dividends and had bought 100 shares of Lumen Technologies on January 02, 2018, you would have paid $17.41 per share, i.e., $1,741. You would have been receiving $2.16 in dividends per year per share i.e., $216 per year (Source: Nasdaq).
By March 12, 2019, the share price was $12.22, and the dividend paid out dropped from $0.54/share per quarter to $0.25/share per quarter.
Therefore, your shares would have dropped in value from $1,741 to $1,222 (a 30% drop) and the dividends per year would have dropped from $216/year to $100/year (a 54% drop).
By the final dividend payout date of September 9, 2022, the share price was $9.97. This meant a further drop in share value of almost 43%. To add insult to injury there would be no further dividend payouts.
On March 20, 2023, Lumen Technologies was removed from the S&P 500 and moved to the S&P Small Cap 600 index instead.
As of September 13, 2023, the share price has plummeted to $1.40 with no dividend.
Therefore, your holdings would have dropped from a purchase price of $1,741 paying a dividend of $216/year to a present-day value of $140 with no dividend.
That is a large price to pay for chasing the dividend.
Lessons Learned from Chasing Dividends
Lumen Technologies offered a very attractive dividend yield to investors. In addition, as a member of the S&P 500, it would have given investors extra reassurance that it was a ‘safe bet’. Wrong!
We can learn some lessons such as:
- Look at the quality and sustainability of the dividend, not just the yield.
- Just because a company has been paying out dividends for years, decades even, doesn’t mean it always will. Dividends are not guaranteed.
- Pay attention to the fundamentals. Analyse the health of the company’s balance sheet, cash flow and income. Review its competitive advantage, growth prospects, and risks.
- Just because a company is currently a member of the S&P 500 does not guarantee that it always will be nor that it will be a great investment.
- Don’t put all or most of your money in one stock. This is highly risky. You could lose all your money.
Stop Solely Chasing Dividends and Consider Changing Your Investment Strategy
Rather than chasing dividends and investing in one single stock, you could diversify, reduce your risk, and invest in:
- Index funds, e.g., S&P 500, FTSE 100
- Mutual funds and Exchange Traded Funds (ETFs) which invest in companies with a high yield and/or who have increased their dividends over time.
- Bonds e.g., corporate or government bonds
- Real estate investment trusts which invest in income generating property and pay out dividends to investors.
If you still want to invest in an individual stock, look for companies with strong balance sheets, good cash flow, and good growth potential, regardless of their dividend policy.
Keep up to date with the company you have invested in as this may affect dividend policy and/or share price. You can do this by, for example:
- reading the company’s annual and quarterly reports
- monitoring news and press releases
- attend and participate in shareholder meetings
- listen to earnings calls
- follow the company’s page on various social media platforms.
Chasing Dividends, Lessons Learned
Dividends are not guaranteed and, as with the example of Lumen Technologies, a company may reduce or even eliminate them completely.
It’s your hard-earned cash. So, do your due diligence before investing in a company. Always pay attention to the latest developments in the company you have invested in.
Thanks for reading!
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DISCLAIMER: Inquisitive Finance operates on principles of exchange of knowledge, ideas and opinions and learning in the community. Your decisions are entirely your own responsibility, and I am in no way responsible for your actions. I am not a financial advisor. Whilst I strive to provide accurate and up-to-date information, I make no warranties or representations as to the accuracy or completeness of this information. Use common sense. Do due diligence and where necessary. Use the services of a licensed financial advisor, before making any financial decision and/or transaction.
