Dividend stocks can be a great source of passive income, but investors need to think carefully about which stocks to buy. Mistakes in this area can be costly.
In the long run, you’ll get the best results by buying shares in quality companies at attractive prices. However, not all companies fit the bill in this regard.
National Grid
A favorite of many income investors National Grid (LSE:NG) shares are trading at a premium and it’s easy to see why – the company is essentially a monopoly in an important industry, and this is unlikely to change.
Surprisingly, this is not a good investment: Competitive protection comes at the cost of regulation, which poses a significant potential threat.
In the US, billionaire investor Warren Buffett has warned of the risks that regulators will stop utility companies from making enough profit – and UK investors would be unwise to ignore this.
In practice this means that National Grid’s profits could be limited by forces outside its control, which is not something I look for in a stock I buy, so I’ll leave that to others to discuss.
Legal & General
Legal & General (LSE:LGEN) shares boast an eye-catching dividend yield of 8.7%, but investors need to consider why that’s so high, and why the share price is down 15% since 2019.
One reason is that the business is fundamentally risky: Life insurance policies have long terms and pricing involves assessing risks that could occur decades into the future.
If things go wrong, the scale of losses could be enormous, and I’m not sure Legal & General has a clear competitive advantage when it comes to pricing policy.
The company has a strong track record with dividends and certainly has the potential to do well, but I believe there are many risks involved in chasing a high dividend yield of 8.7%.
Vodafone
There’s actually a lot to like about it Vodafone (LSE:VOD) shares are currently in a downtrend, with the share price down 48% over the past five years, but there are bright spots ahead.
The company’s biggest problem is the industry it operates in. Hypercompetition in a capital-intensive business is reducing returns for shareholders.
But Vodafone has plans to turn things around, including merging with Three in the UK to create meaningful scale and make the most of existing markets where it doesn’t have an advantage.
This could be a very good strategy, but nothing is guaranteed and while some may be attracted to high-risk recoveries, I prefer less speculative investments.
Dividend Investment
At the end of Indiana Jones and the Last CrusadeThe protagonist tries to identify the Holy Grail among a series of cups, but there’s a catch: the real one gives life, while the false one takes life.
The same is true with dividend stocks: a good one can provide passive income for decades, but a bad one can be a costly mistake.
This isn’t a reason to avoid buying dividend stocks altogether, but it is a reason to be cautious when deciding which stocks are worth investing in.
The post 3 Dividend Stocks I’m Avoiding in the Stock Market Today appeared first on The Motley Fool UK.
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Steven Wright has no position in any of the stocks mentioned. The Motley Fool UK recommends Vodafone Group Public. Views expressed on companies mentioned in this article are those of the author and therefore may differ from official recommendations we make in subscription services such as Share Advisor, Hidden Winners or Pro. At The Motley Fool we believe considering a diverse range of insights makes us better investors.
Motley Fool UK 2024
