With the US Federal Reserve’s decision to hold key policy rates unchanged from the current low levels for an extended period of time, investors can look at dividend income as a means to secure higher returns on their investments compared to the returns from fixed income products. Investments in equities carry the risk of capital loss; however, consistent dividend paying stocks offer scope for steady income with the prospect of capital appreciation in the long run. Companies that pay dividends consistently have stronger cash flows. Stocks of these companies appreciate in value faster than the overall stock market when there is a turnaround in the economy. Information about high dividend yielding stocks is available on all leading finance websites including Bloomberg, Yahoo Finance and MSN Money.
What should you look for in the list of high dividend yielding stocks?
You should see if the company has a consistent history of paying high dividends or if there is a special payout. Since the market price of the stock has a bearing on the dividend yield, it would be worthwhile to check if the price has been beaten down due to poor company fundamentals. In this case, the company would find it impossible to sustain the dividend payouts in the future as the cash flows may prove to be inadequate.
The list of dividend yielding stocks is compiled based on historical data and there is no guarantee that these companies would continue to maintain a high dividend payout.
A good way of avoiding these traps is to actually research the companies’ financial statements. Those companies with strong balance sheets, robust cash flows and a record of consistent dividend payouts should be preferred even if the stocks of these companies do not feature at the top of the list of high dividend yielding stocks.
What are the options available to invest in these stocks?
You have a variety of options to play this theme. A highly risky option is to do your own research and analysis and buy these stocks individually. A less risky option would be to buy dividend focused mutual funds. In the latter option, you let the experts do the job of stock picking in return for a fee that the mutual fund levies as fund management expenses. Exchange Traded Funds (ETFs) that are focused on dividend play have been constructed and made available for trading through the stock exchanges and they offer a good option too. Choosing the right option would depend on your risk appetite (highest when you buy stocks directly and lowest when you buy mutual funds or ETFs), inclination and skill to research on your own and availability of time.
Summary
If safety of capital is of paramount importance, you should invest in fixed income securities or mutual funds that invest in bonds. However, if you are willing to take a little risk in return for the prospect of steady income coupled with possible capital appreciation, dividend yield stocks offer an excellent option. Ultimately, it is your risk tolerance and asset allocation that should determine your allocation to equities.
Daniel Guidotti is a full time financial blogger for Cap Credit and several other finance websites.