The High-Dividend Trap

Investors naturally prefer a stock with cash flow over one without cash flow. However, if you are holding a stock only because it is a "high-dividend" stock, there are a few things you need to examine.

Dividend Payout Ratio and Long-Term Growth Rate

Companies with a high dividend payout ratio have lower long-term growth estimates. A company's long-term Earnings Per Share growth estimate can be expected to be as high as its ROE, but if it loses that much cash to dividends, the long-term EPS growth estimate can be expressed as (1-배당성향) * ROE. In other words, the more dividends there are, the more growth is inevitably delayed.

Is the Dividend Sustainable?

In general, a stock's dividend yield is calculated based on the previous four quarters. What matters, however, is to check whether the dividend yield is high because EPS has recently declined due to lawsuits or a sluggish industry, so the dividend is expected to decline accordingly and has already been priced into the stock but has not yet affected the dividend yield. Free Cash Flow to Equity is a metric that can be used here. If a company cuts its dividend, the stock price will crash once more.

Why Do Companies Pay High Dividends?

A stock paying high dividends means that its appeal other than dividends is that much lower. This is especially true of U.S. oil refiners and banks. With growth momentum weakened, expectations for the stock price are low, and in many cases the stock price is propped up as a way to drive it upward.

Losing the Tax Deferral Effect

If a company uses all of its profits to buy back and cancel its own shares, shareholders' valuation rises, but because they have not sold, taxes do not increase. However, if they receive dividends every year, they lose the tax deferral effect by that amount. If taxes were also paid each year on the appreciated value of the stock, returns would drop dramatically, as shown in the table below.

Conclusion

From an investor's perspective, rather than a company that pays excessively high dividends, wouldn't it be better to find a value stock that pays minimal dividends and buys back its own shares, or a growth stock that can generate greater ROE from the cash it earns?