Avoiding the Dividend Trap: Quality Reigns Supreme

Dividend-paying stocks are often seen as being higher-quality and stabler than their non-dividend-paying counterparts. Thus, they can be viewed as the next step up on the risk/return spectrum between lower-risk bonds and higher-risk stocks. But there is a point at which dividend-paying stocks actually become riskier than the average stock. Earlier this summer, shares of BP (BP) offered a trailing 12-month dividend yield of 9%. This would be a great deal if it was sustainable, after all Exxon Mobil's (XOM) yield is less than 3%. But the market was correctly forecasting that BP's dividend would be cut. Another example is New Century Financial, a subprime mortgage REIT that offered a dividend yield of around 18% at the peak of the housing bubble. That high dividend was nothing more than a trap, as the firm filed for bankruptcy when the housing bubble burst. In this article, we take a look at the ways that dividend-focused exchange-traded funds look to avoid this siren song.... Read more