This assignment was written by Stockpickr member Ira Krakow.
In a volatile market climate (such as the one we're in now), there is often a temptation to buy high-yielding dividend stocks. Buying a stock with a dividend that yields 6% or more is certainly preferable to sustaining a loss of 15% to 20% or more -- a situation that has been typical of even value-oriented stocks in 2008.
Some stocks that an investor lusting after high dividend yields might consider buying include:
Bank of America : 9.66% yield
Diana Shipping : 8.08% yield
Pfizer : 6.96% yield
Southern Copper : 7.29% yield
Permian Basin Royalty Trust : 9.64% yield
Consolidated Edison : 6.16% yield
(Source of dividend yields: Dividend.com)
But before you decide to buy one of these stocks (or any dividend stock), make sure you know the pitfalls, because there are things that can go wrong while you wait for those dividend checks.
Here's an extreme case: Last Friday,
indicated a dividend of $1.00 per share. Based on its closing price of $0.28 per share, that would have represented a yield of 357%. Of course, over the weekend,
. Had you bought IndyMac shares on Friday, you would have never received those one-dollar dividends.
How can you avoid such a catastrophe?
," I suggested two balance sheet ratios to start your dividend homework: the
. If a stock has a payout ratio of 70% or less and a debt-to-equity ratio of 100% or less, then it's a good bet that the company currently has enough assets to cover the dividend.
But beware: While a dividend increase often produces headlines and stimulates shareholder interest, savvy dividend stock investors understand that an increase might not measure up to the hype. For example,
boosted its dividend 10%, from $0.31 per share to $0.34 per share. Sounds great. However, the company also reported a 23% drop in quarterly profit, compared to the same quarter last year. Wells Fargo has $25 billion in cash and $157 billion in debt. Why increase the dividend instead of paying down the debt?
According to Stockpickr's "
Top Dividend Stocks of the W
," banks such as
have cut their dividend because of revenue shortfalls.
Another "head fake" for the investor who focuses solely on the dividend is that, as the stock price decreases, the dividend yield increases. As its price has recently declined, Bank of America's dividend of $2.56 has produced a steadily increasing yield. About a month ago, Bank of America yielded 8.5% based on its $30 share price. Earlier this week, Bank of America yielded over 12% based on a $19 share price. Currently, the yield is over 11% based on a share price in the $27-range. So as a dividend-oriented investor, do you want Bank of America's share price to decline, boosting the yield? Probably not.
Are There Any Other Dividend Increase Head Fakes?
Let's do some homework that could uncover other possible dividend increase head fakes. Your assignment: Find the dividend head fakes.
, create a portfolio called "Dividend Head Fakes:
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
Add five stocks of companies that are increasing their dividend.
To help you get started, review the companies in Stockpickr's "
Top Dividend Stocks of the Week
," search "dividend" on the
and explore the stocks on
For each stock, note the payout ratio and the debt-to-equity ratio in the "Reason?" box.
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.
3. On the Key Statistics page, look for the "Balance Sheet" section. That's where you'll find the current ratio and total debt/equity ratio.
Get more details about why these companies increased their dividend. How? Read company-focused articles on
and other sources, as well as listen to each company's most recent earnings conference call (see
Throughout this process, you are looking for a sustainable investment that should produce dividends from real earnings over the long term, instead of public window dressing or "investor relations" hype.
When you find a company that you think may not be able to deliver its dividend -- long term -- identify it as a dividend head fake.
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