Like any investment strategy, dividend growth investing is not without its risks.

In this lecture, we will discuss some of the most common risks associated with dividend growth investing and how you can mitigate them to optimize your portfolio’s performance.

1. Dividend Cuts or Suspensions: As the cornerstone of the dividend growth investing strategy is the premise that dividends are not only paid like clockwork, but raised each and every year – the possibility of a company cutting or suspending its dividend payouts is the biggest risk. This can happen due to a variety of reasons, such as financial difficulties stemming from lower profits, increased debt levels requiring more cash to service that debt, a change in corporate strategy, or regulatory constraints. Although all risks , it is essential to monitor the balance sheet strength and dividend payout ratios of the companies in your portfolio to anticipate and pre-emptively react to any potential dividend cuts.
2. Overconcentration in High-Dividend Stocks: Another risk of dividend growth investing is overconcentration in high-dividend stocks. While these stocks may provide attractive starting yields, the high yield (as a result of falling share price, not dividend growth) indicates that the market sees something concerning about the company’s prospects. However, this might be also due to a market overreaction and dividend sustainability decision needs to be made based on the fundamentals we have available. During large stock price crashes the market tends to “shoot first and ask questions later” so even very high-quality businesses have at times offered very high yields. To mitigate this risk, it is crucial to diversify your portfolio across different sectors and industries, as well as include a mix of high, average, and low-yielding stocks with various growth potentials.
3. Overpaying/Accepting Very Low Yields: Paying excessive valuations in pursuit of fast dividend growth often lead to sub-par dividend and total returns. Although growth of cash flows is an important part of a successful dividend investing, paying a high multiple and getting a very low initial yield increase the risk of both lower total returns and lower income levels over the long run. Very low yields offer little in terms of compounding from re-investment of dividends – which is the largest driver of dividend stock outperformance.
4. Interest Rate Sensitivity: Dividend-paying stocks can be sensitive to changes in interest rates. When interest rates rise, market participants may shift their capital from dividend stocks to other income-generating investments like bonds, leading to a decline in the demand for dividend stocks and a potential decrease in stock prices.
5. Risk of Underperforming on Total Returns : Dividend growth investing typically focuses on mature, stable companies that pay consistent dividends. While these companies can provide reliable income, they may not always offer the same level of capital appreciation as growth-oriented stocks in certain market conditions. This could result in lower overall returns when compared to more aggressive investment strategies at various parts of the market cycle. To address this risk, a diversified portfolio with various starting yield and growth potential should be constructed.

Conclusion: Dividend growth investing is an attractive strategy for those seeking consistent income and long-term growth. However, it is essential to be aware of the risks involved and take appropriate steps to mitigate them. By diversifying your portfolio, monitoring the financial health of the companies you invest in, and considering valuation metrics, you can optimize your dividend growth investing strategy for success.