Not All Dividends Are Created Equal

Posted on Monday, May 11th, 2009 | In Investing Lessons

Contributed by: Jim Musselwhite (http://www.straightstocks.com) -

Article contributed by guest author Jacob Lindahl of Inside Trading Stocks

Dividend paying stocks can provide a very nice boost to your overall net return on investment,and dividends should certainly be seen as a very positive thing. Especially during very tough stretches for the market, many investors have chosen to look toward high yielding stocks for some form of a refuge. There is absolutely nothing wrong with investing in dividend paying stocks, in fact it is a very good idea, but as an investor you must understand that not all dividends are created equal.

The amateur investor may like to go to a financial site of their choice and simply search for the stocks that have the highest paying dividend yields. This kind of uninformed dividend investing is very risky and dangerous.

It is certainly not enough to simply look for a stock that is paying some kind of outrageous dividend yield such as 20-25% just to hold the stock. In fact, most times you see a dividend yield that is this high it is in fact too good to be true. In the couple of quarters there were numerous financial and industrial companies who saw their shares beaten down so badly that they were yielding over 15% for a short period of time. It is important to note that these stocks had been beaten down for a reason, and almost all of the companies who once had these astronomical dividend yields slashed the dividend in a major way or got rid of it altogether because of a severe need for capital to keep their operations going. In the end the investor who saw that eye popping dividend yield on paper, never got that dividend paid into their account.

What is a healthier way to research dividend yielding stocks? There a few important tips to dividend investing that every investor should know. The first is that a business that continually raises its dividend year after year, even if the dividend isn’t huge, should be seen in a very positive light. It is also extremely important to monitor the cash flows of the company. If a company isn’t bringing in enough cash flow, it will eventually have to cut back on its dividend payments. The ideal dividend stocks are those with a nice dividend yield and a low dividend payout ratio. This means the company has adequate free cash flow to continue paying a healthy dividend while still being able to cover their liabilities, even in a period of economic decline.

The goal shouldn’t be to find the highest dividend yielding stock available, but rather to find the healthiest high dividend yielding stock. There are plenty of stocks out there that yield a very nice amount that also have a very strong business model and a healthy balance sheet. Investors should beware of companies who have propped up dividend yields because of a massive selloff in the marketplace. Focus on the stability of the dividend payout and of the company’s balance sheet as a whole and you will be a few steps ahead of most of the street.