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Dividend Stocks: Safety or Sabotage?

Stocks in this article: ^DJIPFE

NEW YORK (TheStreet) -- There is no question that a well-chosen selection of dividend-paying stocks can be an asset to any portfolio. However, not all dividend-paying stock are the same.

In some cases, corporations that have some kind of difficulty will hike the stock dividend in order to attract yield-hungry investors. It's important to keep in mind that while a strong dividend can signal good things about a company, an exceptionally high yield may signal the opposite.

For instance, the highest dividend yield in the Dow Jones Industrial Average is approximately 5%. While there's no hard and fast cut-off for yields that might be too high, keep in mind that having a dividend yield north of 10% is higher than what investors can earn on most junk bonds.

Don't let a high dividend lead you to neglect doing the basic fundamental research on a stock. In particular, you need to look for cash and growth.

Dividends are paid out of cash. If the company lacks cash, it will have to fund the dividend either through debt or selling stock, neither of which is sustainable.

Before you buy into a company, examine how it has been funding its dividends. Look for any threats to the cash supply, such as high debt or factors that restrict its use of cash. (For example, a large portion of a company's cash might be in tax havens and not available without triggering large taxes.) You can do your own calculations or rely on analysts' consensus.

Dividends are typically paid from cash, and cash comes from earnings. Future earnings will be tied to growth.

Any threat to earnings and growth, therefore, could be a harbinger of a future dividend cut.

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