Stocks with high dividends yields can be a very wise investment. Investing in stocks that pay dividends can provide not only a solid income stream, but as the potential for growth and capital gains. The dividend income generated from owning these stocks can also be reinvested back into purchasing additional shares which compounds future earnings and accelerates real wealth.

Picking Stocks With High Dividend Yields

For all of the solid traits that come with the highest dividend yield stocks, there are also several risks that investors need to be aware of. Chasing the highest dividend yields, for example, can seem like a wonderful investment at first. A dividend yield is calculated by dividend the annual dividend payment by the current earnings per share. As the price of a stock decreases, the company's yield begins to rise. This increase in dividend yield has no influence on the company's financials.

Many of the banks and financial dividend paying stocks were recently found in this situation. Once some of the best dividend paying stocks available, the banking sector has suffered tremendous losses due to the housing market collapse. As share prices declined quickly, the dividend yields rose just as quickly. To the novice investor, a double digit yielding stock from a long time blue chip banking stock would seem like the perfect investment. As times got worse, dividends were eventually cut and the dividend yields begin to come back down.

Lower Earnings Means Dividend Cuts

Stocks with high dividends also may have problems finding the cash to payout their yields. When this happens, companies often announce dividend cuts. Once a company cuts it's dividend, a red flag goes up and investors begin to sell, dropping the value of an investment in the stock.

Careful research and due diligence on stocks that pay dividends can help investors understand if there are any underlying financial problems with the company. The amount of cash a company has and growth opportunities can give an investor enough information to tell them if the dividend can be maintained by the company.

Looking at More Than Just the Dividend Yield

There are more factors investors should consider as the search for stocks with high dividend yields. While a moderate dividend yield is important, other fundamental factors can help screen out the best dividend paying stocks from the pretenders. A good rule of thumb for investors to use is searching for stocks with a yield between 2.5% and 6%.

In addition to the dividend yield, an investor to look from companies that have a price per earnings ratio (P/E) that is fairly low depending on it's industry. Stocks with a P/E ratio below 20 are often considered cheap. The dividend history of the company can also tell a lot about how the company is run and their past performance. Look for companies that have a solid history of raising dividends annually. Finally, focusing on a dividend payout ratio of less than 50% can help narrow down the field of stocks. A company that pays out more than 50% of their earnings in dividends may find it difficult to effectively grow the company.

Picking the best stocks with high dividend yields requires several factors to come together to pick out the perfect investment options.