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TFSA Investors: Why You Shouldn’t Bother With Dividend Stocks That Yield Less Than 2%

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There are many dividend stocks on the TSX that TFSA investors can choose from to help them accumulate wealth over the long term. However, there can be a lot separating dividend stocks, and one of the more important considerations will likely be the yield.

Not only are there very high-yielding stocks that may be a bit risky to invest in, but there are also low-yielding ones that might be more suited to risk-averse investors looking for modest payouts.

While there’s little doubt that investors will be taking on some risk by holding shares that are paying more than 8% or even 7%, that doesn’t mean that investors should be looking for stocks that pay less than 2% just for the sake of stability. I’m not particularly fond of stocks that pay less than 2% in dividends, and here’s why:

The advantage is minimal

If you’re okay with earning 1% or slightly above that amount, chances are you can find something at your local bank that will give you that kind of return. If you can get that type of return from a bank, that tells you that the rate of return is suitable for a risk-free investment.

If you use one of the Big Five chartered banks, you know that you’re money is going to be safe, and so investing your money into shares of a company that may decline is likely not worth the risk, especially if the yield is so nominal.

Even at 2%, it may not be enough of a premium over what you can earn through a bank. I’d generally avoid dividend stocks unless they pay at least 3%, and even that’s still a bit low given that you can earn better dividend yields with relatively safe bank stocks.

One good example is Recipe Unlimited Corporation (TSX:RECP), which currently pays investors a dividend of around 1.8%. While it’s a good top-up for your overall return, it’s likely not going to be the reason you’d invest in the stock.

But having a dividend can be cumbersome for a company, especially one like Recipe Unlimited that has grown over the years via acquisitions.

Why such a low dividend can actually cause problems

Once a company starts paying a dividend, investors expect that it will continue, even though there’s no promise of that being the case. The danger, however, is that if a company decides that it wants to cut or eliminate its dividend, it could hurt its share price.

Any negativity surrounding a stock could do harm to its value, and having to worry about a dividend can be burdensome, especially for a company that’s still growing and acquiring other companies.

While Recipe Unlimited has generally had no trouble generating free cash flow, it hasn’t always been consistent. And having to allocate a big chunk of those funds to paying dividends might not be optimal if Recipe Unlimited could have used that money to help save up for an investment or acquisition that could help increase the company’s value.

Bottom line

Dividends can be a great way to add value for an investors, but that doesn’t mean that it makes sense in every situation. Investing in a company like Recipe Unlimited that looks to be focused on growth while at the same time paying a dividend could lead to less than ideal results for the stock over the long term.

I’d therefore avoid investing in the company simply because there are better yielding stocks out there to choose from, and the dividend could get in the way of its long-term growth.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor David Jagielski has no position in any of the stocks mentioned.

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