Thursday, February 7, 2008

High Dividend Yields, Not Always A Good Thing.

I recently saw an advertisement for an investment website touting a stock with a dividend yield of over 17%. Sound too good to be true? Well there are definitely stocks with extremely high dividend yields, but you have to ask yourself if that's always a good thing. Why is the yield so high? In some cases a stock carries a high yield because the company has fallen on hard times and the stock price has dropped dramatically. If that is the case, how long do you think it will be before the board of directors decide that wisdom dictates a corresponding cut in the dividend payout. At other times a company may have a very high dividend, but they may not have the sales to maintain the payout rate and when a company reduces their dividend you can bet that their share price is going to drop, at least in the short term, because all of the shareholders who invested their money to collect the dividends are going to bale. Certain sectors may also fall on hard times. I personally got clobbered on my investments in real estate investment trusts in the past year. I suppose in retrospect, I should have seen it coming, but regretably I held on to some of these shares way too long. That's why I say it's not always a good thing to buy a stock for the high dividend. It may be better to settle for a lower yield, with potential for future increases, than a high yield that tanks.

You have to do your research and make sure the underlying business can support the payout. You also want to make sure there is room for increasing dividends in years to come. If a company is retaining a portion of earnings, has little debt and is carrying a substantial amount of cash on the books, then it's a pretty safe bet that you don't have to worry about collecting your dividends. Once you've identified a company with good potential and you've made an investment, it's also important to keep up on what's going on with the business. Read the annual reports, keep up with news stories about the stocks you're invested in and the economy in general. If you identify a potential problem affecting the investments earnings and thus their ability to pay the shareholders, it's time to consider selling the stock and investing your money elsewhere.

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