It must be understood by investors that not all yield is equal. We have heard the market pundits talk repeatedly over the past several years about dividend investing—buy those stocks with a good dividend yield and generate some income for your portfolio. Yet the reality is that dividends are not contractual and can be cut or eliminated at any point. And when they are cut, the equity holder most often not only sees the loss of income from the dividend, but the price of their stock also goes down due to investor concerns or people just fleeing the name because they were merely investing for the dividend yield and without that, there is no reason to hold the stock.
But bonds are different. Bond interest payments are contractual obligations, meaning that the only way for a company to stop paying their bond interest is to effectively declare a default and usually a bankruptcy or reorganization ensues. And for a company that has bonds and a dividend paying stock, when management cuts or eliminates that dividend, it is an advantage to us bondholders as it means less cash flow is leaking out of the company to subordinate stakeholders and management often reapplies that cash flow for debt reduction and/or liquidity enhancement. The equity holders’ loss of a dividend is our gain.
So it seems that for those investors looking for true, sustainable yield, you need to turn to corporate bonds.
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