High dividend yield stocks may not be the best investment

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For many investors, receiving a good dividend is their main focus when looking to purchase a stock. In some recent good news, CommSec announced that in the first quarter of 2022 $36 billion in dividends had been paid out, which was higher than the corresponding period in 2021. So, is this a good sign as to the health of the Australian stock market?

The answer depends on why the dividend payout increased. It could be because companies are enjoying good growth and consequently increased profits, and it makes sense to increase the dividend yield. That said, companies are often reluctant to increase dividend yields, as investors expect the yield to be maintained, which may not always be possible.

More likely is that over the past two years of the COVID pandemic, some companies stockpiled cash either to weather the potential storm or to use it for acquisitions. Now that economies are opening up and returning to normality, the excess cash hasn't been needed, so companies are adjusting their cash holdings accordingly.

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Regardless of the reason, it is important for investors to understand that a high dividend yield is never guaranteed, and this is why I always advise to invest for growth first and dividend yield second. I say this because a high dividend yield can result from a company's share price falling heavily, which investors would be wise to avoid.

All too often, investors get caught catching a falling knife because they buy into a stock that has a high dividend yield only to see the share price continue to fall away. Let me say that it is not a good idea to chase a 7% or better dividend if you are losing 30% or more of your capital.

Unfortunately, when this occurs investors tend to validate their decision for buying the stock by saying that because they have not sold, they have not lost. But the better strategy would be to buy a rising stock that is also paying a good dividend. This just makes good investment sense.

The best and worst performing sectors this week

The best performing sectors include Utilities, Energy and Material, which are all up more than 4% followed by Information Technology up more than 3%. The worst performing sectors include Industrials, Healthcare and Communication Services, all down more than 1% so far for the week.

The best performers in the S&P/ASX top 100 stocks include IGO up more than 9% followed by Block and JB Hi-Fi up more than 8%. The worst performing stocks include Fisher and Paykel down more than 11% followed by ResMed and Magellan Financial Group, as they are both down more than 8% while Atlas Arteria is down more than 7%.

What's next for the Australian stock market

The All Ordinaries Index has had a strong week again, rising above the high of 7646 points achieved in mid-February. Given this, I am now confident that the market is in the early stages of a new uptrend and that the weakness over the past few months has abated, while the risk of investing in stocks has decreased.

What is important to remember is that during January and February the masses were fearful of a market correction with many exiting or staying away out of fear. The war in Ukraine, the potential for rising interest rates and increasing inflation were all pushed by commentators as the reason why the market was supposedly going to crash. But this highlights why market noise can lead to fear or greed and result in poor decision making. The rule is not to blindly follow what others are saying.

For those who have remained patient and cashed up, I believe the market will rise to move above 8000 points over the next few weeks, which means smart investors will be rewarded as there are many high-quality, low-risk trades presenting right now.  

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Dale Gillham is chief analyst for Wealth Within (AFSL 226347). He has an Advanced Diploma and Diploma of Share Trading and Investment and more than 25 years' experience in the financial services industry.

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