Dividend stocks are excellent sources of passive income for people building their retirement funds or growing wealth. But to generate a substantial amount of capital, the stock should be paying high dividends. Likewise, you should have a longer time frame to earn meaningful income.
There’s some contention that you shouldn’t rely solely on dividends to optimize returns. You should also be looking at the downsides of investing in dividend stocks. Companies pay dividends to keep shareholders happy and remain invested.
Another reason is that management has no better growth opportunities to invest its retained earnings. However, the most significant risk is when your stock stops paying dividends or implements a dividend cut.
When that happens, your earning potential diminishes and your stock’s value drops. You might find it difficult to recover your losses. As such, you should be careful in choosing dividend stocks.
Massive dividend cut
Let us take the case of SNC-Lavalin (TSX:SNC). The company was established in 1911 and has since been operating as an engineering and construction firm. SNC-Lavalin provides consulting, design, engineering, construction, and operation, and maintenance services globally.
The share price of SNC-Lavalin was at $45.85 at the beginning of 2019 and even climbed by 6.1% to $48.65 at one point in January. When the issue of corruption erupted later in the month, it was all downhill for the stock. As of this writing, the price is down to $15.91, or 65.3% lower than the value on January 2, 2019.
But the horrible news to investors came on August 1, 2019. SNC-Lavatin announced an 80% dividend cut on account of the company’s $2.2 billion net loss in Q2 2019. In addition to the dividend drop from $0.10 per share to $0.02 per share, the stock posted a new 14-year low.
The losses of Caisse de depot, SNC-Lavalin’s largest investor with a 20% stake, since January is close to $875 million. The anomaly at SNC-Lavalin will deprive its most significant investor of $11.2 million in dividends.
Final thoughts on dividend stocks
Several factors could affect the payment of dividends. Apart from a company’s short life cycle, geopolitical risks, heightened competition, integrity issues, and now the trade war could force companies to stop dividend payments or make drastic cuts.
In a rising market, growth stocks could outperform dividend stocks and deliver higher returns. But dividend stocks are better options in a declining market. The case of SNC-Lavalin is lamentable. Investors lost money from the dividend stock
Rising interest rates could also impact on dividend stocks. If the yield of a 10-year bond increases to 5%, dividend stocks with the same return or lower lose their appeal. Bonds are more or less risk-free investments. Fortunately, we are in a low-interest environment.
If you’re starting to build your stock portfolio, you should have a longer investment window. Choose dividend stocks wisely to receive a steady income stream. The company should be financially stable and has an excellent dividend track record.
More importantly, the company must be trustworthy and free of integrity issues that could massively disrupt business operations.
