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Why the High Dividend-Yield Screen Fails? (Dividend Stocks 101 Series)

November 07, 2012 | About:
Dividend stocks have been the favorite of many investors, whether because of a preference for regular income or an aversion to risk. This is one of many in a series of articles where I reveal the nuts and bolts of investing in dividend stocks.

Dividend yield is calculated as the dividend paid per share divided by the stock price.

Dividend yield is commonly perceived as the cash return in dividend income you will receive by buying the stock. Dividend investors typically screen for high-dividend yield stocks to build up their dividend portfolios.

Caveats in buying high dividend-yield stocks

That Was Last Year's Dividend, Not This Year

Dividend yield is often calculated using the dividend paid out for the last financial year. Dividend yield can be distorted by special dividends which are repeated this year. Also, for companies which pay out dividends as a fixed percentage of net income, last year's dividend is no indication of this dividend since earnings are unpredictable.

Dividends Aren't High, Prices Are Low!

At times, unfamiliar faces appear in the high dividend-yield screen. It could be a one-time increase in dividend last year or simply that the stock price collapsed, artificially creating the illusion of sustainable high dividend yields. Furthermore, falling share prices typically reflect deteriorating fundamentals and reduced ability to pay dividends, at the very least in the short term.

In Closing

There is nothing wrong with using high dividend yield as a metric to screen for dividend stocks. However, investors should do their homework on the dividend payouts and not buy a basket of high dividend yield stocks blindly.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He publishes value investing case studies, investment checklists, and potential stock ideas on the Cheapskate Investing blog. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website

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