Not many people realize the dangers of dividends. They believe that shopping for stocks that pay out high Dividends is the best way to make money month after month.
The average person will look for stocks with high dividends. It doesn’t matter if it is a good company or what the price is doing.
The problem with that is because in order to invest successfully a trader must know something about the stock that they are investing in. Let us look at an example.
Stock A is trading at $40 but they pay out $.5 in dividends every 3 months. The only problem is that it has been in a downtrend for the last 6 months. Stock B is also trading at $40. It has been in a very nice uptrend for the last 6 months. The stock is strong; the only problem is that they do not pay out dividends.
Most beginning traders are likely to pick Stock A. They see it as a nice way to pull out income from their stock. Most professional traders would likely pick stock B. Because the stock has been in an uptrend it is likely to continue going higher. Likewise Stock A is likely to go lower.
After a year the buyers of Stock A made $2 or 5% return from their dividends. They accomplished in making an income. Stock A however is now trading at $24. This is because it was a weak stock to begin with. They may have only paid out dividends to get people to invest in their company.
The owners of stock B however didn’t get any income from their stock. They were however rewarded in buying a strong stock. The stock they once bought for $40 is now trading at $120. They made a 200% increase from this trade.
Most traders will make money by investing in high quality stocks. They do not care if a company is paying out dividends or not.
Now that is not to say that it is wrong to buy stocks with dividends. That just should not be the reason someone buys a stock. An extra 5% income from dividends is not going to make much of a difference anyway.
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