One of the reasons that people invest in dividend paying stocks is in order to create an increase in cash flow into the personal economy. Being able to do this is one of the advantages of dividend paying stocks. You need to be careful, though. When using dividend paying stocks as a source of stable income, it is important to choose solid investments that will provide cash flow that is fairly reliable.
Beware of High Payouts
The basic formula for dividend yield is Annual Dividends per Share/ Price per Share. The result is expressed as a percentage. So, let’s say that you are to get $0.80 each quarter. That amounts to $3.20 per share each year. Perhaps the stock is trading at $75 a share. You divide 3.2 by 75 to get 0.04267. Multiple by 100 to get your percentage: 4.27% is your dividend yield. High yields are attractive because the assumption is that you will get a bigger payout.
You have to be careful of high yields, though. A popular example from recent financial history is that in the early months of 2008, Lehman Brothers had a 13% dividend yield. Do you remember what happened to Lehman later that year? That’s right: The company collapsed and helped trigger a global financial crisis. A high dividend payout is likely to be unsustainable. Additionally, a high yield could indicate that the share price is plummeting. Take our example above. If the share price drops from $75 to $40, all of a sudden the dividend yield is 8% (3.2/ 40). The yield has gone up, but the company might actually be in trouble. And your payout hasn’t actually risen.
Choosing Modest Dividend Yields for Stable Cash Flow
When a company has a high dividend yield, it could mean that they are a start-up trying to attract money, or that they are in a position that is unsustainable. Either way, there is a good chance that your yield could drop in the near future, lowering your income. If you are trying to increase your cash flow, this can create a problem.
Instead of chasing high yields, look for companies that have a yield of between 3% and 6%. These companies are often solid, with a long history of paying dividends. Such companies, like Kellogg’s, Coca-Cola , Pfizer and Johnson & Johnson are reasonably stable companies that have paid dividends for years.
While a dividend cut is always possible, you can reduce the chances of experiencing one when you look for solid companies. While they may not be flashy, if you are looking for stable cash flow, companies with dividend yields between 3% and 6% might be a good bet.