This assignment was written by Stockpickr member Ira Krakow.
A great way to give your portfolio a boost is to look for stocks
paying high dividends (see
Value Stock-Picking: How to Find Top
Dividend Plays"). Yes, with a good dividend-paying stock, you
can get the potential double reward of dividend income and
stock price growth.
In addition, a dividend sets a "floor" on the
stock price. So if the stock price goes down, then the dividend yield goes up. This attracts
investors looking for income. When that happens, with more buyers,
the stock price goes up.
Why You Need to Look Beyond a High Dividend
It's not enough to just pick the highest dividend-payer from a
. If you do only
that, you risk investing in a company that might not really be able to
pay that high dividend, which could lead to a double whammy: the
dividend could be cut, or eliminated entirely, and the stock price can
go south as well.
Before you buy a high dividend-paying stock, you need to look at
the company's financials to determine whether there's enough cash to
cover the dividend payment -- now and in the future. To help you
gauge the health of a company's dividends, there are a few ratios you
can check out.
First, look at the company's payout
, the percentage of earnings
that the company pays as a
dividend. A payout ratio of 70% or less generally means the dividend
is safe. If the payout ratio is greater than 100%, that's a warning
signal. For example, Citizens Communication (CZN)
, which has a
dividend yield of 9.3%, also has a 256% payout ratio. Why so high?
Perhaps it's using debt or selling assets
to pay the dividend. You need to
research the company and find out.
Next, check out the debt-to-equity ratio
current ratio, which are measures of the level of assets relative to
If a company is
carrying a lot of debt relative to its assets, that should set off an
alarm bell. As with the payout ratio, a debt-to-equity ratio or
current ratio over 100% could mean that the dividend might not be
sustainable, and a rate of 70% or less is considered a safe level.
Reviewing these ratios will help you avoid being seduced by
impossibly high yields. Take Frontline (FRO)
, an oil tanker
carrier with a yield of 16.6%. Is this astronomical dividend
Its payout ratio of 109% and current ratio of 179%
should give pause before clicking the buy button. On the other hand,
perhaps the oil tanker business is so profitable that the company can
continue to pay the rich dividend. Again, when you see ratios like
this, you need to dig a little deeper to find what's going on.
Keep an Eye On the Flip Side
On the other end of the dividend spectrum, when a company cuts its
dividend, it's often a sign of trouble, as with La-Z-Boy (LZB)
a furniture manufacturer hit hard by the housing slump, or Flagstar
, a troubled mortgage lender, which eliminated its
Your Dividend Stock-Picking Assignment
Your assignment is to find dividend stocks with healthy
, create a
portfolio called "High Dividend Stocks: [Your Stockpickr Username]."
(To create a portfolio on Stockpickr, you'll need to first log-in. If
you're currently not a Stockpickr member, you can register at www.stockpickr.com/register
Select five dividend stocks from Stockpickr or
TheStreet.com, by searching for the keywords "dividend" or
To help you get started, check out: High
Yield Warren Buffett Stocks
Dividend Stocks You've Never Heard Of
on Stockpickr, and
"The Top Dividend Stocks of the Week
For each stock, go to Yahoo! Finance and note the stock's payout
ratio, current ratio, and debt/equity ratio. At the end of the
trading day, record the closing price in the "Reason?" box on
Here's how to find the dividend-related ratios on Yahoo! Finance:
1. On the specific stock quote page, click the "Key Statistics"
link on the left hand side of the screen.
2. On the Key Statistics page, look for the "Dividends and Splits"
section. That's where you'll find the payout ratio.