High Yield Stocks Are Home Wreckers

| May 15, 2015 | 0 Comments

You know what really sinks a lot of dividend stock investors?

High yield stocks…

Somebody thinks he’s found the best dividend stock because there’s a high yield.

The high yield looks good for a week, maybe even a month after the dividend investor buys it.

Then there’s a dividend cut because the high yield gets too expensive for the company.

The company is living beyond its means, and it just can’t afford to pay those kinds of fat dividends any more.

And when there’s a dividend cut, the stock price usually takes a hit.

You’ve got a high yield dividend stock disaster.

And you probably know what happens next.

The investor sells the stock for a loss and rushes off to pick up what he thinks will be one of the next best high dividend stocks.

You see what’s happening here?

The cycle repeats itself.  One losing trade leads to another.

The best way to break this pattern is to stop focusing on high yield.

A Better Approach To High Yield Stocks

For starters, stay away from any stock that pays a yield of more than 10%.

But even when you see a yield that’s more than 5%, you want to be careful.

And you want to think about hanging onto your dividend stocks longer.

When Warren Buffet buys a stock, he buys it to hold forever.

Well, that’s how it’s been for Buffet the past 50 years.  Back in the 1950s and 1960s, he was more of a buy and sell guy.

Mario Gabelli is another terrific investor you may have heard of.  He runs big funds and he’s basically a value investor.  A value investor looks for stocks the market undervalues.

Quite often, it might be a situation where the market has overreacted to bad news and has been too harsh driving down the stock’s price.

The value investor shakes down the stock and sees a rosier future than the market does.

Mario Gabelli typically looks for a 50% return on a stock within two years before he even thinks about selling.

Holding on for at least two years, even if you don’t enjoy the kiss of a 50% return, gives you a good shot at more appreciation potential in the years ahead.

When it comes to finding stocks with the best dividends, I’m happy to pay attention to guys like Buffet and Gabelli.

Mario Gabelli owns some interesting dividend stocks, and they don’t tend to pay high yields.  He’s been buying Freeport-McMoRan $FCX, a natural resource company into mining and energy, and Petsmart $PTSM, the pet supply retailer.

Both stocks deliver yields of less than 1%.  But Gabelli figures he’ll do just fine with dividend growth and share price growth.

He’s not getting in line to chase high dividends.  He’s trying to find stocks he figures will do well, and throw off some income, over the next few years.

So we can go to school on Gabelli.  We can use his stock picking technique to make smarter choices on your dividend stocks.

Here’s one way to do it the same way investors like Mario Gabelli does.

It’s a simple way to zero in on the best stocks.

Playing It Safe To Find The Best Stocks That Pay Dividends

Use this easy way to take the temperature on the safety of a high yield stock that most investors don’t know about.

I call it the dividend cash cushion.

The dividend cash cushion shows you if the company is dipping into its savings, or even borrowing money, to pay the dividend.

If so, watch out.  You want the company paying for the dividend with cash that’s coming in.

Here’s how to do the easy arithmetic.  Divide the total annual amount of dividends paid by the total annual free cash flow.

You can find both these numbers on your favorite finance site.

And don’t forget to keep an eye on the dividend payout ratio.  That’s where you see what percentage of quarterly income goes to pay dividends.

You can turn up some scary stuff… even when you’re not looking at high yield stocks, and yields are down below 4%.

Reynolds American, $RAI, pays a dividend of 3.54% and has a dividend payout ratio of 69.7%.

Eli Lilly, $LLY, pays a dividend of 2.77% and has a dividend payout ratio of 63.5%.

Paychex, $PAYX, pays a dividend of 3.08% and has a dividend payout ratio of 82.2%.

See what happens?  You turn up big, impressive companies that might seem pretty solid, but are actually flashing some nasty warning signs.

No wonder billionaire investors like Mario Gabelli seem to think the best dividend stocks crank out lower yields.

And no wonder he’s not concerned that the Freeport-McMoRan stock has been skidding.

That’s the nature of the beast.  The way it behaves.  Take a look at this 10-year chart…

Freeport-McMoRan $FCX

Based on the stock’s history, you can see why Mario Gabelli figures Freeport-McMoRan is in a good position to increase in value by 50% over the next two years.

And pay some nice dividends along the way.

It’s a great reminder of the trouble you can get into when you’re so focused on stocks with the highest dividend yield that you’re blindsided to everything else that’s going on.

There’s plenty of trouble to get into.  And none of it is worse than the trouble that comes with a dividend cut.

How bad can it get?

High Yield Stocks Can Clean You Out

Sometimes, the dividend cut is the alarm that goes off before bankruptcy.  It happened with RadioShack, and with Washington Mutual.

Seven years after it shattered the dreams of its shareholders, I’m still disgusted with Washington Mutual.  They hurt a lot of people.

Why none of their executives were hit with criminal charges for cooking the books is one of the mysteries of our time.

In 2011, after three years of investigating, the feds on the task force examining the WaMu failure claimed they couldn’t come up with any evidence of criminal violations.

But the dividend cut was the handwriting on the wall.

At the end of 2007, Washington Mutual slashed its 56-cent dividend down to 15 cents.

The fat 5% yield was gone.  And less than a year later, Washington Mutual declared bankruptcy.

According to Standard & Poor’s, during that ugly last quarter of 2008, 288 companies cut their dividends.  In 2009, another 804 dividend payments were cut.

No, all these companies didn’t go bust.  A dividend cut doesn’t mean bankruptcy is in the cards.  But it usually does mean there’s trouble.

You never want to downplay the importance of a dividend cut.  And you never want to forget that the higher the yield, the better the chances of a cut.

Stay away from those high yield stocks that can turn into home wreckers.  Stick to the dividend stocks that are in a position to keep growing their dividends.

That’s how you’ll create income.  That’s how you grow your portfolio.

Use my dividend cash cushion, and you can be tipped off about trouble before it happens.

Regards,

Michael Jennings
Dividend Stocks Research

Note:  Michael Jennings writes and edits DividendStocksResearch.com.  Sign up for our free dividend reports and dividend newsletter at http://www.dividendstocksresearch.com/free-sign-up.  We’ll show you how to create regular income by investing in dividend stocks, easily, step-by-step.

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Category: Dividend Stocks

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Michael Jennings is the Editor of the Dividend Stock Research site. Dividend Stock Trading can be difficult. Michael Jennings provides you step by step guidance through the rough world of Dividend Investing.

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