The Dangers Of Some High-Yield Dividend Stocks

Dividend stocks are a powerful way to build up your portfolio, but you must keep in mind that not all dividend stocks are created equal. Investors with little experience purchasing dividend-yielding stocks often look only at the dividend yield of the stock, which is a large mistake. There are certainly times where high-yielding stocks are a great investment, but there are other times where a high dividend yield is a sign of underlying problems for the company. It is important to realize the dangers associated with dividend-yielding stocks that look too good to be true. When is a high-dividend yield a warning sign? There are a couple quick ways to gauge the dividend yield of an individual stock. The first metric you should take a look at is the dividend payout ratio. This tells you what percentage of the company's net income is being paid out in cash to shareholders. One positive of this tool is it can be measured with ease by simply taking the annual dividend per share and dividing by the annual earnings per share. What is the typical dividend payout ratio? Most experts consider a ratio of anywhere from 40 percent to 60 percent to be quite normal. Levels higher than 60 percent are seen as excessively high. When a dividend payout ratio is too high, the company isn't able to invest back into their business to create future growth. Payout ratios of 60 percent or higher are also warning signs that the company may have trouble continuing to pay this dividend in the near future. A more basic way of considering whether a high-yielding dividend stock is dangerous is by simply following its recent trading action. When a dividend yield becomes attractive solely because a stock has dropped precipitously in price, it is a large warning sign. A good example of this was Bank of America Corporation (NYSE:BAC) during the credit crisis. The stock was yielding upwards of 10% for some time, but the writing was on the wall, and the company slashed their dividend in a big way. Bank of America is now only yielding one cent per share. How can you go about finding a safe high-yield dividend stock? There are two methods I like to use to spot safe dividend stocks as well. First of all, take a look at the dividend payment trends from this company. If you are able to spot a company that has consistently raised dividends for many consecutive years, chances are this is a winner. A good example of a high-dividend yielding stock that has raised its dividend payouts annually for quite some time is Johnson & Johnson (NYSE:JNJ). Johnson & Johnson is currently yielding 3.45 percent, and the company has raised dividend payouts for 48 straight years. Another method to help you spot a healthy dividend yield is free cash flow. A company with consistent free cash flow growth should be able to support dividend increases in the long run. Look at both the history of dividend payouts from the company, as well as the free cash flow trends. As long as you are diligent in your research, you should be able to find plenty of healthy dividend-yielding stocks. Remember the old adage "If it looks too good to be true, then it probably is." Not all dividend stocks are created equally, and some high-yielding dividend stocks are dangerous investments.... Read more