High dividend stocks are traditionally seen as a safer, less exciting method of investing, often useful for producing a steady, if unspectacular return on investment. Dividend stocks are available from more mature companies that produce a stable amount of profit that does not need to be reinvested in the company, so is issued to shareholders as income.
Young, start up companies
do not usually pay out dividends as they require start-up capital, and all profits are reinvested in growing the company. Investing in these companies can be lucrative in the long run however, with a low share price and the potential to grow they can give a huge return on investment. However, it is also high risk proposition because it is also possible that the investment could simply be lost entirely, if the company fails or as with the case of Facebook recently, had an overpriced IPO.
Established Companies Most Likely High Dividend Stocks
Generally, high dividend stocks will be available from well established companies, with the highest dividends coming from the companies you already know about. For example, Coca-Cola (KO: NYSE) will normally pay a large dividend rate. It makes huge profits and is not very likely to lose its commanding market position any time soon.
Editor’s Note:
Currently Coca Cola is only yielding 2.5% down from 3.1% a year ago. But the major advantage of Coke (KO: NYSE) is that it has a history of increasing its dividends regularly. So if you invest and remain invested you will get steadily increasing returns on your original investment as time goes by. One good method of investing for your retirement is to buy high dividend stocks with your IRA money and then to consistently reinvest those high dividends during your working life. That way the number of shares of the high dividend stocks increases during your working years both from new investment and dividend reinvestment and then upon retirement you can switch to receiving the high dividends as income.  Using this strategy Warren Buffett is currently earning a 39% yield on his original 1988 investment in Coke.
Always a Risk
There are always risks attached with any company. Take the UK’s most popular Sunday newspaper, The News of the World for example. Scandal forced the paper into oblivion. While this is not an example of a company going bust as it’s holding company continues, it hurt investors badly. An institution with 140 years of history, seemingly a very secure component of an investment in a large multi-national company, suddenly was no more. This is why you shouldn’t have all your eggs in one basket but should diversify over several high dividend stocks (preferably 10 or more so if one goes to zero you will lose less than 10% of your nest egg.)
Beware of Bargains
If you are looking for a bargain dividend stock to pay you high dividends, there will be a reason that the stock is a bargain. It is a risk. Often a stock that has had a recent decline will be listed as a high dividend stock. This could be because the statistics use dividend history to calculate dividend yield and as a company’s stock price declines its dividend yield increases (as long as it actually continues to be able to pay its dividend.) If there is a financial reason for its price decline it is possible that its dividend is at risk as well.
Many of the ratios used to evaluate dividend stocks can be misleading, as with any statistic in life. It is important to understand the business and why the statistics have come about. A high previous dividend yield coupled with a low price to earnings ratio may suggest to one analyst that the stock has been undervalued and appears a bargain, but to another analyst it could suggest the company is on the decline.
Dividends are at the Board’s Discretion
Finally, there is never a guarantee of a dividend. Companies decide whether to pay them out based on financial results. Should strategy change, or corporate structure, personnel, they can easily decide not to pay a dividend and reinvest the profits instead. However, large companies that have a history of increasing dividends yearly would have a difficult time changing course and suddenly becoming a growth stock.
See Also:
- What are High Yield Bonds?
- What Is Factoring Accounts Receivable?
- Investing in a Mutual Fund
- Invest in Structured Bonds?
- Bank Runs Can’t Happen- Right?
James McDonnel is a financial enthusiast who contributes to sites like Next Financial Group and Fintrend.
Image courtesy of digitalart / FreeDigitalPhotos.net
