America is a place where "more" is often considered
Two pizzas for the price of one…supersized sodas (before
Michael Bloomberg banned them)…suburban McMansions…
So it's no surprise that income investors focus on yield when
analyzing a dividend stock. Yield is of course crucial when
investing for income.
After all, it's an easy measure of how much income you'll earn
from your investment. But time and time again, I see investors
make the same error.
In their quest for good investment income, they put on
blinders and consider only yield. The logical conclusion is that
stocks with the highest yields must be the best investments.
But nothing could be further from the truth.
Many investors mistakenly focus on yields that are "high."
They seek stocks paying dividends of 8%, 9% and even 10% or more.
After all, the bigger the dividend, the more money they can
expect to earn.
But there's one big problem. Some companies paying out these
big dividends can't afford them.
Big yields often are the result of falling share prices. After
all, when a stock price falls, the dividend yield will rise. And
that's exactly what can make some dividends appear large.
Of course, the dividend of a falling stock is unlikely to stay
high for long. There's a reason the share price fell in the first
place. And those fundamentals will usually end up taking down the
dividend as well.
Investors are of course advised to avoid any company that's
reducing its dividend.
Let's take a look at one risky dividend stock. That company is
Frontier Communications (
, one of the highest yielding common stocks.
Frontier pays a very healthy 9% dividend - a yield that should
attract lots of interest. However, a closer look reveals all
sorts of problems.
Frontier is a telecom company that is primarily in the
business of wired phone lines. As you know, this business is
shrinking, as more consumers ditch their landline in favor of
their wireless phone.
That means expansion for companies like AT&T and Verizon
that have big wireless businesses. But it's a major problem for
companies like Frontier.
And that's reflected in Frontier's dubious financial
performance. The short story is that the company's revenues and
profits are both falling. And the company's 22 cents in earnings
per share won't be enough to pay its 40-cent dividend.
In many ways, that 9% dividend is a mirage. It's just a matter
of time before Frontier will be forced to cut its dividend
And when the dividend is reduced, plenty of investors will
dump the stock. You and I know that when there is more selling
than buying, share prices fall.
Now, Frontier isn't unique. There are plenty of other
companies in a similar predicament. I could just as easily have
- both companies are paying out unsustainable dividends.
The unfortunate fact is that many companies paying out high
yields can't afford their dividend. They're living beyond their
means, but are unwilling to change their ways for fear of losing
My final word of warning is this…
Make sure that your dividend stocks are financially sound. If
their earnings and cash flow don't cover the cost of the
dividend, you could be in for a nasty surprise.
I want you to earn a healthy income from your investments. But
I'm just as concerned about protecting your wealth by avoiding
risky stocks. And even some "safe" dividend stocks are risky
Do you own any high yield dividend stocks that may be
risky? If so, send me an email with the details. I'll be
doing a reader mailbag issue of
Income & Prosperity
later this week, and will be happy to analyze a few top
subscriber holdings. My email address is