The 6 big problems with dividend shares

In theory, buying high-yielding dividend shares can deliver superior investment returns over time. In practice, these six issues can get in the way.

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As an older investor seeking passive income, I like dividend shares. Actually, most of my family’s unearned income nowadays comes from these cash payments that companies make to their shareholders.

The downsides of dividend investing

In an ideal world, I could make money simply by buying stocks that offer market-beating dividends. Alas, this world is far from ideal, so this is no ‘get rich quick’ scheme.

For example, here are six problems that I have to deal with as a dividend disciple:

1. Only some shares pay out cash

Almost all shares in the blue-chip FTSE 100 index pay out dividends. However, this proportion reduces rapidly as I move into the mid-cap FTSE 250 and smaller companies. That’s why the Footsie is my #1 hunting ground for cash streams.

2. Payouts are not guaranteed

Unfortunately, future unpaid dividends are almost never guaranteed. Therefore, they can be cut or cancelled with hardly any notice. This happened a lot during the Covid-19 crisis and continues today among companies that need to preserve cash.

3. Yields are usually historic

When I look up the dividend yield of a particular share, it’s important for me to establish whether it is a trailing (historic) or forecast (future) yield. Also, if a firm has recently cut its payout, then this may not be entirely apparent, so I always dig deeper into its public announcements.

4. The dividend curse

Sometimes, listed businesses that pay out large proportions of their profits in dividends neglect to invest sufficiently in future growth. When this happens, I occasionally notice it by spotting long-term declines in share prices over, say, three and five years.

I call this effect — hefty dividends undercut by falling share prices — the ‘dividend curse’.

5. Debt and divvies

Paying out large sums in cash to shareholders over time can leave a company’s balance sheet looking shaky or stretched. Also, some firms prefer to increase their net debt rather than prune payouts to their owners.

6. The ex-dividend drop

The ex-dividend date is the day that new shareholders no longer collect the next dividend. Thus, buying stock before this day secures me the dividend, while buying on or after the ex-dividend date means I don’t collect it.

Hence, share prices usually drop on ex-dividend dates to reflect the loss of this cash reward.

Vodafone’s dividend dilemma

One classic dividend share is Vodafone Group (LSE: VOD), the UK’s largest telecoms operator. My wife and I bought this stock in December 2022 for 90.2p a share.

On Wednesday, 20 March, Vodafone shares closed at 67.28p, valuing the group at £18bn. To date, we are nursing a paper loss of over a quarter (-25.4%) on our purchase. Furthermore, this stock has dropped 27.2% over one year and has crashed 54.3% over five years (excluding dividends).

Notably, the firm’s yearly dividend payout has been frozen at €0.09 (7.7p) per share since 2019. This lack of growth may be a warning sign of cuts to come. As it happens, the group just announced that it will halve this payout in 2025, consequently halving the dividend yield from 11.6% to 5.3% a year.

That said, Vodafone intends to buy back €4bn of its shares using the sale proceeds of non-core businesses. Therefore, I have no intention of selling our stock for the immediate future!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Cliff D’Arcy has an economic interest in Vodafone Group shares. The Motley Fool UK has recommended Vodafone Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services, such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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