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When things go well, dividend shares can provide investors with a reliable stream of cash through the year. And that might be helpful if the stock market crashes and shares suddenly become cheap.
Everyone wants to be able to ‘buy the dip’ but waiting for a crash is a risky business. But dividend stocks might offer the best of both worlds – being in the market while having cash available.
The dilemma
If you think share prices – especially in the tech sector – are looking a bit high at the moment, you’re not alone. A lot of investors are saying some parts of the market are in a bubble.
Investing in these conditions isn’t easy. I for one find it extremely uncomfortable buying shares when I think they’re trading for more than their intrinsic value.
The trouble is, valuation by itself doesn’t make stocks go down. So if you sit and wait for a correction, by the time prices fall you might find you just end up either buying at a higher level.
Worse still, there’s no rule that says share prices have to come down at all. Stocks that have got beyond their fundamentals might just trade sideways until the businesses catch up.
The result is a real dilemma for investors. If you buy when prices are high you can’t really complain if they fall, but if you wait for a drop then you risk missing out entirely.
Enter dividend stocks, which might let investors participate in a rising market while also receiving cash returns that they can use to take advantage if prices fall. That’s the theory, but does it work?
An example
Diageo‘s (LSE:DGE) a FTSE 100 company with a good record of growing its dividend over time. At the moment, there’s a yield on offer of just over 4% which is unusually high for the stock.
So could the stock provide an investor with ammunition to use in a stock market crash? I think the answer is that it depends on what causes it.
If the next downturn comes as a result of weak returns from artificial intelligence (AI) spending, Diageo shareholders could be in a good position. This has nearly nothing to do with the company.
On the other hand, if it comes from US tariffs creating a trade war, this could be much more of an issue. The FTSE 100 firm has operations in various countries and could be affected in a big way.
Inventory levels at alcohol distributors are relatively high at the moment, so higher import costs could have a big effect on the company. And this is something to watch out for.
Wholesalers, however, can’t just use existing inventory indefinitely. They’ll have to restock sooner or later and this is why Diageo’s strong brands and wide distribution are a long-term strength.
Stock market strategy
I think the strategy of using dividend shares to try and take advantage of stock market downturns while staying invested is a decent one. But it needs a diversified portfolio of investments.
The way to minimise the risk of any particular threat is to try and own some assets that are less exposed. I think Diageo’s worth considering as part of that approach, but not by itself.
This story originally appeared on Motley Fool
