Topic: Dividend Stocks

The highest yield dividend stocks: What to buy & what to avoid

September 7, 2020|by Pat McKeough

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The highest yield dividend stocks are great for your portfolio if there’s a history of paying a dividend and the high yield isn’t misleading

The dividend yield is an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters.

The highest yield dividend stocks may be attractive, but they can also be misleading. An attractive yield, and especially a very high dividend yield, can give you a false sense of security. That’s because many investors have a tendency to think that all investment income is almost as safe and predictable as bank interest.

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Approach the highest yield dividend stocks with caution

Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high-yield can sometimes be a danger sign rather than a bargain. For example, a dividend paying stock’s yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut. That’s why we recommend that you look beyond dividend yield when making investment decisions, and look for companies that have also established a sound business and a history of building revenue and cash flow.

The biggest risk in the highest yield dividend stocks

When looking for stocks with high dividend yields, you should avoid the temptation of seeking out stocks with the highest yields—simply because they have above-average yields.

That’s because—as we mentioned earlier—a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high dividend yield that has been maintained or raised during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

A track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will be profitable for you in the future.

Putting the highest yield dividend stocks in your portfolio

The best stocks to hold in your portfolio all have one thing in common: They give you reason to believe they might be worth holding on to indefinitely.

Most of these stocks have an established business and a history of sales gains, plus some earnings, if not dividends. To put it more simply: these stocks have a clear business plan that seems to be working.

Of course, stocks like these will still suffer in a deep market downturn. They may also suffer in the shallower, shorter downturns that come along more often. But most recover quickly when the market revives, as it always does. In fact, stocks like these may lead the inevitable market recovery.

These are the kind of stocks we put in our clients’ portfolios. Though we think they are worth holding on to indefinitely, we keep an open mind. After all, they are subject to the usual risks.

High quality stocks + high quality dividends = a winning combo for the highest dividend stocks

Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks. For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.

The highest yield dividend stocks can be a part of long-term investment gains

If you stick with top quality high dividend paying stocks, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.

Good dividend stocks are a valuable component of any sound investment portfolio. But note, though, that when it comes to investment safety, a long history of steady dividends is just as important than a current high dividend yield.

Dividends add up when you invest significantly in one stock. What’s your minimum investment for a dividend stock?