03:07 am
June 28, 2017

7-Point Checklist for Investing in High-Yield Dividend Stocks

7-Point Checklist for Investing in High-Yield Dividend Stocks

Here’s how to make sure you’re buying the right kind of high-yielding stocks.

High-yield dividend stocks, which I’ll define as those yielding more than 4%, can be the perfect investments for generating income in your stock portfolio. They yield more than most bonds, they have the potential for capital appreciation, and their payouts can rise substantially over time. However, as with any other type of stock, there are some high-yield stocks you should avoid at all costs.

With that in mind, here’s a seven-point checklist to help you narrow down your search.

1. Check the payout ratio

This is the No. 1 metric to look at when evaluating a dividend. A company’s payout ratio is simply the ratio of the dividends it pays out to its earnings. For example, if a company pays an annual dividend of $1 and earned $4 per share in profits, then its payout ratio is 25% ($1 / $4). A lower payout ratio is better, as it signals that the company has plenty of profit to cover its dividend. A high payout ratio (especially one over 100%) can be a red flag that the dividend is unsustainable and thus in danger of being cut.

There are some notable exceptions to this. Real estate investment trusts (REITs) and business development companies (BDCs) are required to pay out at least 90% of profits to shareholders, so in those industries, a high payout ratio isn’t necessarily bad news. Plus, earning aren’t a great metric to use for REIT profitability – it’s better to use funds from operations, or FFO, when computing the payout ratio.

2. Stick to larger companies

There are a few exceptions to this rule, but I like to stick to dividend stocks that have a market cap of $1 billion or more and are listed on a major U.S. exchange. Larger companies tend to be easier to analyze: They’re generally more established, which means they have a long history of revenue and (hopefully) profitability. And because more analysts follow bigger companies, you can find more information and analysis on them.

Finally, while there are exceptions, stable profits usually imply stable dividends.

3. History repeats itself

An investment’s past performance doesn’t guarantee its future, but it can help predict it — especially when it comes to dividends. Companies that have increased their dividends every year, without interruption, tend to continue doing so. So, before you invest in a dividend stock, check the last several years of its dividend history. Better yet, start your search with the S&P High-Yield Dividend Aristocrats Index, which is made up of 107 high-yield companies that have raised their dividends for at least 20 consecutive years.

4. Return on equity (ROE)

Return on equity is a great metric for gauging how efficiently a company uses its assets to produce profits. The average ROE of the companies in the S&P 500 has historically fluctuated between 10% and 15% most of the time. As a personal preference, I like to stick with companies with a ROE of at least 10%, and even higher is better. As with most of the other points on this list, there are exceptions, but solid profitability is a sign of a healthy business.

5. How much debt does the company have?

Debt isn’t necessarily a bad thing, but too much debt can be a fatal flaw. Specifically, if a company’s interest expense is high, then a dropoff in its profits could leave it struggling to make the payments on its debt and pay its dividend. As an example of a company with a healthy debt load, Procter & Gamble‘s 2015 net interest expense was $626 million — less than 10% of its net income of about $7 billion.

6. Understand why the dividend is so high

Companies pay high dividend yields for several reasons, some good and some not so good. I already mentioned the case of REITs and BDCs, which have to pay out the majority of their profits in order to avoid corporate taxes. Another common reason for a high dividend is a mature business — in other words, if a company isn’t trying to grow aggressively, then it doesn’t need to reinvest much in its business, therefore more profits are available for dividends. AT&T is an example that immediately comes to mind.

However, if the dividend yield is high simply because the stock price has dropped by 50% over the past six months, then that’s a sign of trouble that you should investigate.

7. Is it too good to be true?

Finally, it’s important to realize that there is no free lunch in investing. If a dividend sounds too good to be true, chances are that it is. As a rule of thumb, if a stock yields more than 8%, then the dividend is likely unsustainable or at least inconsistent. It’s safest to stick with stocks with down-to-earth yields.

High-yield dividend stocks can be an excellent addition to your portfolio, as long as you do your homework before investing. Make sure the dividend is sustainable and the underlying business is healthy, and you’ll avoid wealth-destroying high-yield traps.

The $15,834 Social Security bonus you could be missing
If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after.  Simply click here to discover how to learn more about these strategies.

Matthew Frankel owns shares of AT&T. The Motley Fool recommends Procter and Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

Forget Netflix! We Think These 3 Companies Are Ready to Take Off

Let’s face it… cable television is on its way out and the “death of TV” means the $2.2 trillion entertainment industry is ripe for the picking. Right now, there’s a golden opportunity to hijack cable’s profits as Americans continue ditching cable. Because we think three stocks are poised to surge now that cable TV’s days are numbered. And you’d be surprised… Netflix and Amazon.com aren’t even on the list! Click here to learn more.

58 comments

  • It’s actually a cool and useful piece of info. I am glad that you simply shared this
    useful information with us. Please keep us informed like this.
    Thank you for sharing.

    Reply
  • My spouse and I stumbled over here different web address and thought I may as well check things
    out. I like what I see so i am just following you. Look forward to
    going over your web page again.

    Reply
  • Attractive section of content. I just stumbled upon your web site
    and in accession capital to say that I get actually enjoyed account your weblog posts.
    Any way I’ll be subscribing in your feeds and even I
    success you get admission to constantly fast.

    Reply
  • magnificent issues altogether, you simply received a new reader.
    What could you recommend in regards to your post that
    you simply made some days in the past? Any sure?

    Reply
  • Hello! Quick question that’s completely off topic. Do you know how to make your site mobile
    friendly? My weblog looks weird when viewing from my iphone4.
    I’m trying to find a template or plugin that might be able to resolve this problem.
    If you have any recommendations, please share. Appreciate
    it!

    Reply
  • Oh my goodness! Incredible article dude! Thanks, However I am experiencing problems with your RSS.
    I don’t understand why I cannot subscribe to it.
    Is there anybody getting the same RSS issues? Anybody
    who knows the solution can you kindly respond? Thanks!!

    Reply
  • Hey there! This post could not be written any better!
    Reading this post reminds me of my good old room mate!
    He always kept chatting about this. I will forward this article to him.

    Fairly certain he will have a good read. Thanks for sharing!

    Reply
  • We’re a group of volunteers and opening a new scheme in our community.
    Your web site provided us with useful information to work
    on. You have performed a formidable process and our whole neighborhood will probably be grateful to you.

    Reply
  • You are so cool! I don’t believe I’ve truly read through a single thing like that before. So good to discover somebody with some original thoughts on this subject. Really.. thank you for starting this up. This site is something that is needed on the web, someone with a bit of originality!

    Reply
  • I don’t even know the way I ended up right here, but I assumed this
    publish was good. I don’t understand who you’re but definitely you are going to a famous blogger
    if you happen to are not already. Cheers!

    Reply
  • This is really interesting, You are a very skilled blogger.
    I have joined your rss feed and look forward
    to seeking more of your excellent post. Also, I’ve shared your
    site in my social networks!

    Reply
  • May I simply say what a comfort to uncover somebody who really understands what
    they are talking about on the web. You definitely understand how to bring
    a problem to light and make it important. A lot more people must check this out and
    understand this side of your story. I can’t believe
    you are not more popular because you surely possess the gift.

    Reply
  • Hello there! This is my first visit to your blog! We are a group of volunteers and starting a new initiative in a community in the same niche.
    Your blog provided us useful information to work on. You have done a marvellous job!

    Reply
  • Hi there this is kind of of off topic but I was wanting to know if blogs use WYSIWYG editors or if you have to manually code with HTML.
    I’m starting a blog soon but have no coding
    knowledge so I wanted to get advice from someone with experience.
    Any help would be enormously appreciated!

    Reply
  • Good day very nice site!! Guy .. Beautiful
    .. Amazing .. I will bookmark your website and take the feeds also?

    I’m satisfied to search out a lot of helpful information here
    in the submit, we want work out extra techniques on this
    regard, thank you for sharing. . . . . .

    Reply
  • Hi there! I just wanted to ask if you ever have any
    trouble with hackers? My last blog (wordpress) was hacked and
    I ended up losing several weeks of hard work due to no backup.
    Do you have any solutions to prevent hackers?

    Reply
  • Today, I went to the beach with my children. I found a sea shell and gave it to my 4
    year old daughter and said “You can hear the ocean if you put this to your ear.” She put
    the shell to her ear and screamed. There was a hermit crab inside and
    it pinched her ear. She never wants to go back! LoL I know this is
    completely off topic but I had to tell someone!

    Reply
  • Howdy just wanted to give you a quick heads up. The text in your content seem to be
    running off the screen in Ie. I’m not sure if this is a formatting issue or something to do with internet browser compatibility
    but I thought I’d post to let you know. The design look great though!
    Hope you get the problem solved soon. Cheers

    Reply
  • I have been browsing on-line greater than three hours today, yet
    I never discovered any attention-grabbing article like yours.
    It’s beautiful worth enough for me. In my opinion, if all website owners and bloggers made excellent content material as you did, the net will be a lot more useful than ever before.

    Reply
  • Attractive component to content. I just stumbled upon your blog and in accession capital to
    assert that I acquire actually enjoyed account your weblog posts.
    Anyway I’ll be subscribing for your feeds and even I achievement
    you get right of entry to consistently quickly.

    Reply
  • Have you ever thought about publishing an ebook or guest authoring on other
    blogs? I have a blog based on the same subjects you discuss and would love to have you share
    some stories/information. I know my subscribers would appreciate your work.
    If you’re even remotely interested, feel free to
    shoot me an email.

    Reply
  • Just wish to say your article is as amazing. The clarity
    in your post is simply excellent and i could assume you’re an expert on this subject.
    Fine with your permission allow me to grab your feed to keep updated with forthcoming post.
    Thanks a million and please continue the enjoyable work.

    Reply
  • hey there and thank you for your information – I’ve definitely picked
    up something new from right here. I did however expertise a few
    technical points using this web site, since I experienced to reload the website
    many times previous to I could get it to load properly.

    I had been wondering if your web hosting is OK? Not
    that I am complaining, but slow loading instances times will sometimes affect your placement in google and could damage your quality
    score if advertising and marketing with Adwords.
    Well I am adding this RSS to my e-mail and could look out for much
    more of your respective intriguing content. Make sure
    you update this again very soon.

    Reply
  • Wow, wonderful weblog layout! How long have you ever been blogging for?
    you make blogging look easy. The total glance of your site is wonderful, let
    alone the content!

    Reply
  • hi!,I love your writing very so much! percentage we
    communicate extra approximately your post on AOL?
    I need an expert on this space to solve my problem. Maybe that
    is you! Looking forward to see you.

    Reply
  • Woah! I’m really loving the template/theme of this blog.
    It’s simple, yet effective. A lot of times it’s tough to get
    that “perfect balance” between usability and visual
    appeal. I must say that you’ve done a amazing job with this.
    Also, the blog loads super fast for me on Opera. Exceptional Blog!

    Reply
  • My spouse and I absolutely love your blog and find the majority of your post’s to be what precisely I’m looking for.
    Do you offer guest writers to write content to suit your needs?
    I wouldn’t mind composing a post or elaborating on most
    of the subjects you write about here. Again, awesome website!

    Reply
  • This is very fascinating, You are an excessively professional
    blogger. I have joined your rss feed and sit up for looking for
    more of your excellent post. Additionally, I have shared your website
    in my social networks

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *