DEFINITION of 'Sucker Yield'

This chase for yield in the stock market leads to the same thing that all such chasing leads to – impulsively reacting to dividend quantity over dividend quality. A “sucker-yield” is based on quantifiable high yields, seemingly ridiculous, when the underlying security has a flawed or vulnerable business model. Companies that fall under the “sucker-yield” definition typically have unpredictable and unreliable earnings histories with unsafe dividend payouts.

Investors oftentimes are distracted by high paying dividend yields as they become seemingly hypnotized by the allure of owning securities with substantial income. However, the impulsively promising investments offer a greater degree of principal loss since the investor has crossed into a less defensive asset allocation strategy of speculation. As a true measure of safety, it's critical that investors analyze the underlying safety of the dividend, the ability for the dividend to grow, and the overall merit of the stock.

BREAKING DOWN 'Sucker Yield'

In the business of investing, as well as real life, the words “too good to be true” means that “all the glitters is not gold.” If a stock seems to pay a dividend yield that is exceptionally high, investors should look harder at the sources of payment behind the dividend. That is, how profitable is the company? Can the sources of income cover the dividend payment? How sustainable is the dividend? Are there threats to the underlying business model?

When a company is paying a dividend beyond its earning power it is essentially eroding capital. Suppose an investor purchase shares in a company that is paying a dividend yield of 10%. The company has a track record of cutting dividends and its balance sheet has considerable leverage. The investor buys $100 in the company and receives 10% in dividends over 10 years. At the end of 10 years, the shares are worthless because of declining earnings induced by poor operating fundamentals. The investor has essentially risked all of his capital for the sake of the high dividend – or sucker yield.

It’s important to recognize that there are two ways to make money in the stock market – capital appreciation and dividends. When a stock is paying an extraordinarily high dividend yield combined with an unsustainable business model, there will almost always be loss of principal. Investors should always proceed with caution and focus more on dividend safety than dividend yield. Be careful of chasing sucker-yields as “the raised nail always gets hammered.”

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