Don't Be Faked Out by High Dividend Yield

Most of the daily scrutiny of the stock market is focused on stock prices. And yet, thousands of companies pay dividends to shareholders with relatively little ongoing attention. However, if you invest primarily in dividend-paying stocks, you’re well aware of the value of that quarterly income.

And if you’re among those who haven’t spent much time considering dividend stocks, you probably should be aware that chasing the highest yields might not be the best approach.

“Dividends can be a great source of income for investors,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “But it’s also important to understand that there may be risks to those potential rewards. Investors should do their homework before buying an individual stock, or consider buying mutual funds or exchange-traded funds that hold dividend-paying securities.”

Going for Yield

Dividends are expressed in two ways: a dollar amount per share and the yield, expressed as a percentage. The dividend yield – which is the annual dividend paid per share, divided by the share price – gets the most attention.

So why doesn’t everyone just grab the investment with the highest yield? Because high yields can be temporary or a cause of concern.

  • Yield vs. stock price. Yields rise and fall inversely with stock price (assuming no change in the dividend). So if a company’s stock price has fallen, the yield will rise (assuming the dividend per share remains the same). But if investors flock back in, chasing the higher yield, the stock price likely will increase – which will send the yield back down. The bottom line is that dividend yields are not fixed. They can fluctuate with stock prices.
  • High yields and risky companies. Repeating a point from above, yields rise as stock prices fall. But if stock prices have fallen, that could signal a company in trouble. So high yield could be a bad sign.
  • Dividend cuts. There is no guarantee that a company will increase its dividend or even keep the dividend the same. In fact, it is not uncommon during challenging business environments for companies to cut dividends. Your high-yield company today could be a low-yield or no-yield company tomorrow.

“Investors should recognize that just because a company pays a dividend, it doesn’t mean that company is less risky than a company that doesn’t pay a dividend,” Correnti said.

How to Find Dividend Stocks

At Scottrade, there are several ways to find dividend-paying stocks. You can log in and, on the Quotes & Research tab, click Investor Tools. Once there, you can create screens to find stocks, mutual funds or ETFs that pay dividends. You can filter by dividend yield, annual dividend and other dividend-related criteria.

In addition, there are pre-defined stock screens related to dividends.

If you’re not a client, you can also screen by dividend yield on the Quotes & Research page.

Question: What do you look for in a dividend-paying security? Do you prefer individual securities over funds?

Next Steps: Learn more about reinvesting dividends commission-free with Scottrade’s Flexible Reinvestment Program®.

Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.

Investors should consider the investment objectives, charges, expense and unique risk profile of an exchange-traded fund (ETF) or mutual fund before investing. A prospectus contains this and other information and should be read carefully before investing. A prospectus is available through www.scottrade.com or through a Scottrade branch office.

The information and content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

More Articles & Insights

Using Stock Downturns to Your Advantage With Long Puts

Buying puts can be an effective strategy to help protect your financial assets in a market downturn, however there are risks.

Saving for College: How to Get Started

There are a variety of education savings accounts available to help defray the cost of higher education, each with distinct advantages.

Long Calls: A Way to Leverage Your Investment

Using long calls as an option trading strategy can help you turn a larger profit if a stock price increases. However, it may result in the loss of the premium.