There are a number of stocks that pay high dividends available to investors. Some of these securities are good investments while others come with a very huge risk. Many of the riskier dividend investments actually have a double digit yield which may seem like a wonderful investment to the uneducated investor. The reality is that just because a stocks dividend yield is high, doesn't mean it is a good investment.
Many of the highest dividend paying stocks are actually some of the most riskiest investments around. The high yield that is associated with these investments is often unsustainable for long periods of time. In many cases, a very high yield is actually an early indicator of financial problems within the organization.
Investors looking to invest in quality stocks that pay high dividends should screen for the best investment options available. Following the steps below is one way to narrow down the best dividend stocks from the riskiest.
Things You Will Need
- Online Discount Broker
- Internet Access
Search for stocks that pay dividends with a strong past performance of increases. A company with a solid dividend history is much more likely to maintain or raise its annual payout. A company with a history of raising and lowering the annual dividend are considered a higher investment risk for income investors. Stocks that continue to raise their annual dividends every year provide important information to investors of how well the company is run.
Review the dividend payout ratio of any stock that you may consider buying. The payout ratio represents how much of the stocks earnings are being used to pay the dividend. The general rule of thumb used by most dividend growth investors is to stick with a dividend payout ratio of 50% or less. A company with a payout higher than 50% is seen as a risky dividend stock investment. As more and more of the earnings are used to sustain the dividend, the harder it is for the company to maintain its payout.
Focus on stocks that pay dividends with a yield between 2% - 6% (give or take). The yield is calculated by dividing the annual dividend payment by the current earnings per share. There are safer investment options compared to a stock with a dividend yield below 2%. A certificate of deposit or high yield savings account will typically offer a higher return at no risk. On the other hand, a stock with a yield over 6% has more risk as history has shown us. Companies that have a yield over 6% have a difficult time maintaining their payout.
Select blue chip stocks that pay dividends with a low P/E ratio. A P/E (or pricer per earnings ratio) is a calculation representing the current share price versus the annual earnings. Many long term investors select stocks with a P/E ratio of 20 or lower. Depending on the industry, most stocks above 20 are considered too expensive whereas those under that amount are thought of as discounted. Blue chip stocks all have a good dividend history and are some of the best run companies around.
Watch for a stock that has a frozen or dividend cut. As far as income stocks go, a company that freezes (i.e. no increase for over 4 quarters) or cuts its dividends should be a warning sign. Following a companies dividend announcements is actually a very good way to tell the overall health of the company. A dividend cut means the company is short on cash while an increase proves that business is still operating well.
Tips & Warnings
- Never chase the highest yielding stocks as it is virtually impossible to maintain double digit dividend returns.
- Ignoring the warning signs of a dividend freeze or cut could cost an investor lots of missed future earnings.