Beware the Siren Call of High Yield Stocks

Beware the siren call of high yield stocks. Fat dividend yields can seem very alluring, particularly in this low interest rate environment. But investors are usually better off sailing right past them. Many high yield stocks have very little room to raise their dividends over time or invest for future growth. And even a small drop in income can lead to a dividend cut. While dividend cuts are most common during recessions, they can occur at any time, as you can see here. When it comes to dividend investing, the tortoise often beats the hare. That’s why investors should focus on dividend growth potential more than the current yield.

Income-hungry investors need to keep a long term perspective and consider where a company’s dividend might be in the future. There are several factors to consider when determining a company’s dividend growth potential. One important metric to consider when analyzing the sustainability and growth potential of a company’s dividend is its payout ratio. The payout ratio is simply the percentage of net income a company pays out to shareholders in dividends. There is a tradeoff between high dividends and long-term earnings growth. Obviously the more cash a company pays out to its shareholders, the less it has to fund growth without either issuing more debt or more equity. That can be a dangerous game to play. However, it’s not uncommon for solid businesses to distribute more and more of their earnings to shareholders through higher dividends as they mature.

Source: InvestorPlace

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