It is very common to hear from analysts that in time of uncertainties in stock markets, their advice is to move into high yield and defensive stocks should one still maintain vested or for long-term investment purposes. Reason for that was that the high dividend yield per annual is able to cushion the pull back in stock prices and defensive stocks are companies whose businesses are resilient in uncertainty economic situation and hence the stock prices will not fall more than higher beta one.
There is true to the above advice but there are something more investors need to consider before plunging in to heed the advices from those analysts.
1. High dividend yield stocks must be those with good fundamental and consistently throughout the years regardless of economic situation be able to pay out the dividend to shareholders. Most of those stocks that fitted well into such description are REITs.
2. Defensive stocks applicable to those whose businesses serve the basic necessity of the people like food, healthcare, transportation, utilities, etc. If such company is having monopoly in its business that would be an added advantage as it can pass down the cost to consumer. More important, these defensive stocks must have a good past records of ability to pay out dividend to shareholders regardless of economic situation.
3. Most use the dividend yield to decide on whether to invest in these stocks. Technically, it is correct but needed that extra consideration that during the economic down period, such companies even with their resilient in businesses, they too also will suffer a drop in business revenue which affect their cash flow and hence the amount of dividend payout. Take example if a stock X trading at $1.00 and presently is able to offer a dividend payout of $0.08 per annual which translates to 8% dividend yield. Under economic down period, with company earning take a hit, the absolute of dividend payout could also be reduce and hence at $1.00 cost, the dividend yield then will be much lower than 8%. A rough guide is under economic down period, a factor of 1% to 2% drop in dividend yield is possible. As the dividend drop, the share price will move down to reflect in a cut in the dividend payout.
When an investor decides to invest in these high yield and defensive stocks, the investor must be mentally prepared that under economic down period, with reference to their investment price, there will be a drop in dividend yield ( absolute amount of dividend payout ) and also potentially paper losses due to a drop in the share prices. At many a times investors only look at the positive side ( ie getting 8% dividend yield now and might be higher next time when economic becomes even better ) and forget about to consider for the downside. When such a case happens, when share price drops ( dividend yield drops ) they can be disheartened in their investment and at times when emotionally over-rule rationale, they sell it off with a loss.
It is the ability of an investor to stomach the downside risk that should be the first priority in consideration when invest in these high yield and defensive stocks. This is something probably you can never read or hear from analysts when they do a recommendation in investing in these stocks.
Should an investor is clear about the downside risk and able to stomach those, do not act hastily in straight away pour any single capital available into the investment and should strategize in buying those stocks. Always remember the downside risk, stock will get dirt cheap then and always maintain certain amount of cash so that in the event of dirt cheap price, you will have the cash to accumulate more at great bargain.
