Sometimes, when building a dividend stock portfolio, it can be tempting to chase the highest dividends yields. However this is not always the best idea. Indeed, many recommend that a yield target of 4% to 6% is ideal, and even that 2% to 3% is acceptable. That can sometimes seem a little low, especially when you consider that there are yields of more than 8% – and even yields of more than 13%.
One of the reasons that some companies offer such high dividends is to encourage others to invest in shares. There are some smaller companies or start up companies that offer high yields in order to try and get more investors. If you are looking for something short term, this might not be a bad idea in some instances. You could see high yields, and make money. However, if you are looking for a long term investment or stable income, higher yields aren’t always the best answer.
Issues Associated with High Dividend Pay Outs
There are some issues that you have to be aware of when you see high dividend pay outs. When a company pays high dividends, it is paying a portion of its profits. Making high dividend payments cuts into the cash that a company has available. Companies may not be able to sustain such high payments for an extended period of time. If you are counting on dividend payments for regular income, you might be disappointed if the company can’t sustain high pay outs for a long period of time.
Another problem is that sometimes high dividends are used as a way to attract investors – even though the company isn’t stable. Sometimes, high dividend yields can be a cover for a company that is crumbling. You could find yourself invested in stock that turns out to be worthless later.
Finally, you might be wary of dividends that fluctuate. You might see high dividends for a couple years, and then see a dividend cut later. If dividends fluctuate regularly, it can be difficult to set up a regular income portfolio. High dividend stocks, even those that fluctuate, can be interesting additions if you are looking for growth instead of income (especially if you reinvest), but you may not be able to rely on them for regular income.
Screening Dividend Stocks
A good way to filter out bad dividend payers is to look for stocks that have a solid dividend history of raising dividends. Our safe dividend list has stocks that have been raising their dividends for 25 years or more. You should also pay attention to the payout ratio and dividend growth rate. We like stocks that have a payout ratio under 60 and a dividend growth rate of 5% or more. Take a look at the top dividends list for more info.
Even if you do use high yield dividend stocks as part of your strategy, it is wise to be careful, and to keep an eye on the news about the companies involved so that you can sell your stock at signs of trouble.