Tuesday, November 25, 2008

High Yield Does Not Equal Quality Stock

I have seen and heard a lot of people these days talking about buying Citigroup, because it is (as of this writing) yielding 17%. Using the rule of 72, an investment earning 17% would pay for itself after 4.23 years. That is an insane rate of return. There are a number of stocks out there that are yielding a very high level. I admit that these stocks can seem very tempting to an investor. Even though I sold my Citigroup holdings a while back after the most recent dividend cut, I must admit I thought that the 17% yield is hard to pass up.

However, stocks have abnormally high dividend yields for a reason - they are either a MLP or income trust or they are seriously in trouble! It is pretty obvious that Citigroup is in serious trouble. They key to a high dividend is to ensure that the company can continue to maintain the dividend that is leading to that high dividend yield and I don't think that Citi is even in the ballpark of doing that. It is important to remember that dividends only come from one place - earnings. If the company cannot earn enough in earnings to pay for that dividend than it does not matter how hight the yield is, you are basically knackered.

Another thing to note is to determine what has driven the share price down. If the company has just been dragged down by the overall market and as a result the yield has gone up, then perhaps it is worth looking further into the company. However, if the stock has tanked due to its own financial mismanagement or some other management blunder then that dividend may not be sustainable through earnings.

So, in markets like the ones we are faced with today, do not get suckered in by a high dividend yield. Determine what is driving that increase in yield and then decide if it is worthy of chasing that yield!

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.

1 comment:

  1. You can always look at the dividend payout ratio. If the payout ratio is too high, it means a large percentage of earnings are being used to fund the dividend payout, which is not good. Citigroups was 42% last year, while the sector average is 15.49%

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