Avoiding Dividend Cuts
6/11/2010 11:42 AM EDT
As if things weren't going badly enough for BP (BP) investors, the embattled company is now considering cutting its dividend to ease anger caused by the spill. While the story of this dividend-splicing might be the most noticeable to investors today, it's not the first time that shareholders have been let down by dividend-paying investments that suddenly become less attractive.
The problem with high-dividend firms is that they often are on shaky ground. While an improving economy is helping to ease the risk of default, the status of high-dividend paying companies can often change rapidly. Investors looking to reap the rewards of high-dividend paying firms should approach the process with a strategy.I recommend gaining exposure to the group through the iShares Dow Jones Select Dividend Index (DVY), a fund that I have owned for more than six months. Not only does DVY's structure inherently reduce security-specific risk, but the fund's methodology also helps to protect investors from companies that are prone to cut down dividends. In order to be included in DVY's portfolio, dividend-paying companies must first have certain criteria:
- DVY is comprised of 100 of the highest-yielding dividend securities (excluding REITs) in the Dow Jones U.S. Index, a broad-based index representative of the total market for U.S. equities.
- Companies must have a current year's dividend-per-share ratio, which is greater than or equal to their five-year average dividend-per-share ratio.
- Companies must have an average five-year dividend payout ratio of 60% or less.
- Companies must have a minimum three-month average trading volume of 200,000 shares a day.